Investors seem to be panicking while fundamentals continue to surprise on the upside. Our take
Monday’s S&P return of -4.1% was the largest one-day decline since August 18th, 2011. All indications point to a positioning-driven sell-off, a continuation of last week, as fundamental data remains strong, both on the macroeconomic side (strong ISM in the US, strong PMI in the Eurozone) and the microeconomic side with earnings results surprising positively. All the different regions have shown similar equity losses at the opening this morning. The recent sell-off of fixed income markets may have also been a factor, putting pressure on some systematic strategies.
The move on the volatility index (VIX) was more extreme than any other major market with short-term VIX future-based products rebalancing. The VIX increase of 20 points was the largest absolute change ever. The current level of the VIX implies the S&P should move an average of almost 2% daily which would represent a significant change from the recent low-volatility environment if it continues; for context, Friday was the S&P’s first 2% one-day move since 2016. Current higher realized volatility (18% in 2018) is not nearly high enough to justify the current level of the volatility index.
The debate today is whether Monday’s spike in volatility cleared the deck of volatile short-options positions or if it will lead to further buying of volatility to cover the implicit short volatility positions among investors.
Systematic strategies (volatility targeting, risk parity, CTA’s…) may contribute to further outflows in the days ahead. That being said, and even if in the very short-term markets may remain volatile, there has been a massive divergence between strong market fundamentals and equity price action over the last few days. Ultimately, we think that the current market correction represents a buying opportunity.