October started with a huge sell-off that lasted pretty much the entire month. In late October markets started finding some support and November so far has been about equity markets going higher and volatility imploding, i.e. the inverse to October.
We have covered the crowded trades extensively, especially the volatility space.
Just before the October sell-off started, we argued VIX was going to be the best global risk hedge. Back then investors had piled into huge shorts in VIX, all discounting calm markets ahead.
The following panic lower in equities was accompanied by a huge spike in VIX and other volatilities. Shorts had to run to cover their exposure as gamma was starting to make delta hedging impossible.
Just before the last pop higher in equities, and the recent downturn in volatilities, we reversed our stance and argued for the long VIX logic to have had played out well and we even suggested volatility was pricing too much risk and that VIX was trading way too rich.
Part of our argument was the fact risk managers have taken tighter control of the p&l, resulting in short volatility strategies being forcefully closed out. We can now see that is exactly what happened, as the below chart shows how extremely short VIX futures went from net short to actually small net long. This gives further support to our logic equity markets need to catch some breath before any further big moves can resume.
Below chart showing net non-commercial VIX futures (white) versus VIX index (orange).
Another important risk indicator, the credit markets, has continued to show less stress.
Below is the iTraxx main (European main credit, white) and European volatility index, V2X (orange). We can clearly see both have come off, especially the credit index which is somewhat of a hybrid between cash and volatility.
Last time credit was here was in early October. V2X is down lately, but still at relatively more elevated levels as the volatility shock takes usually more time to flush through the system.
All in all, both volatility and credit markets are showing less stress and we believe this could go on for a little longer. The same people that spoke about panic and that one should buy protection when equities traded at lows are now starting to talk about volatility going lower. We expect volatilities to continue falling until media pundits start talking about how little volatility this market is showing.
We all know what the media has been telling us, blame the sell-off in China and Emerging Markets. Interestingly enough, the EEM US has outperformed the SPY massively during the October sell-off.
It seems more crowded trades continue blowing up as inverse panic continues for a little bit longer.
Source: charts by Bloomberg