How Blue is the Sky?
The VIX index with a 9 handle is not a frequent occurrence. It only happened three times since the launch of the VIX index back in 1992. Yes, 25 years ago. It says a lot about the markets, as the attached FT article points out.
It also highlights the latent uncertainty that was associated with politics in Europe.
With the Dutch and French elections behind us, both with positive outcomes, especially vs the alternatives, the markets' blood pressure seems to have overreacted and gone to "beyond healthy". In markets parlance, we are solidly in "Risk On" mode. This may seem surprising given the myriad uncertainties the world faces. An important factor driving this is that interest rates are still historically low. To put this in perspective, even if VIX was at 9%, a classic rule-of-thumb calculation suggests that the theoretical price of a 1-year at the money option (call or put) on the S&P 500 would be c. 3.6%, vs 1.4% for the current 1-year USD swap rate. In other words, the seller of 1-year at-the-money S&P 500 put options would receive a yield that is more than 2.5 times the amount of interest she would get in the inter-bank rate market, before fees. This is why yield-hungry investors continue to sell volatility, even at these levels, thereby applying massive downward pressure on implied volatility, and making it indeed a rather distorted measure of risk.
The sky just cleared up a bit, but it may not be as blue as the VIX indicates. Our core multi-asset models, which have performed very steadily so far this year, continue to suggest a moderate equity exposure, and a low or even negative duration in USD terms. We think such positioning remains wise and recommend keeping a close eye on future re-balancing events.
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Financial Times Article - "Wall Street’s fear gauge falls to lowest level since 1993"