There's No Bubble in Equities But There's One in VIX, Says JP Morgan's Top Strategist Kolanovic
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Marko Kolanovic, the Global Head of Macro Quantitative and Derivatives Strategy team at JP Morgan, expects the S&P 500 to continue marching higher as VIX settles around 20.00.
Kolanovic and his team of strategists don’t believe equities are trading in a bubble. However, certain stocks in sectors such as electric vehicles (EV), renewable energy, and innovations - may generate a bubble.
“The current market turmoil is a result of pro-risk sector and style rotations, away from speculative growth and bond proxies, and inflows into value and cyclicals. In fact, this strong rotation resulted in market moves grinding to a halt, and 2-week realized volatility of the S&P 500 dropped to ~5%, levels that were last seen in 2017,” Kolanovic wrote in today’s note sent to clients.
“While there is a lot of talk about bubbles – it is hard to see one in the broad equity market, where a dominant group (FANGs) practically hasn’t moved for 6 months despite massive amount of stimulus and an expected economic recovery, Financials that have barely recovered 2020 losses, and Energy that is still down 25% from last year despite a commodity bull market.”
He stresses that Cboe’s volatility index seems “disconnected to underlying short term S&P 500 realized volatility,” which is showing a bubble of fear and demand from investors looking to hedge or profit from a potential market selloff.
In laymen’s terms, VIX is currently trading in a bubble. Therefore, with VIX trading at a near-record premium to actual equity volatility, Kolanovic sees a case for selling the “VIX bubble”.
“Reiterating the reasons why we think the VIX is bound to decline: 1) Positive macro fundamentals of monetary and fiscal stimulus, as well as recovery from pandemic; 2) Strong rotation from growth to value/cyclicals that is keeping correlation between stocks low. In fact, in the last 2 weeks, despite large moves in sectors and factors, the S&P 500 has remained largely unchanged;
“3) Low volatility drives inflows, triggering a positive feedback loop of a rising market and declining volatility – despite some warning of a ‘var shock’ what we are seeing now is ‘var inflows’ with volatility targeters/risk parity funds adding (rather than reducing) ~$1.5bn in equity exposure daily; 4) Gamma hedging reducing S&P 500 volatility, and long VIX positioning (e.g. via ETPs, see here) limiting VIX upside,” Kolanovic adds.
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