Is 5th Time The Charm For Equity Vol?

Tyler Durden's picture

While most mainstream market watchers will pontificate wildly on the VIX as indicative of whatever their whimsy of the day tends to be, we prefer to look at relative performance. The forward-looking implied vol is currently only just below its multi-year average premium to realized volatility (so a low VIX is not that exciting standalone). Realized volatility is pretty much as low as it has been in the last four years, courtesy of the Fed - and each time has been followed by a resurgence soon after. However, there is one more indicator of potential over-exuberance that offers some hope for traders - the spread between SPY (S&P 500) implied vol and HYG (high yield debt) implied vol is at its lowest since the crisis - and each of the previous four times this spread has been this narrow, we have seen notable weakness in stocks soon after. With HYG so 'cheap' to stocks, it seems being long HYG vs. short SPY, or long SPY vol vs. short HYG vol makes some sense for some low vol cheap protection.

 

HYG remains significantly dislocated from SPY since the start of the year... is the market pricing for a massive releveraging? Perhaps - but it seems everyone forgets the leverage cuts both ways and with credit managers now more selective, firm WACCs are going to rise and weigh on equity valuations...

 

Equity realized vol has decayed rapidly back to its long-term lows - VIX is 'not cheap' relative to realized vol (lower pane), even if it appears 'low' in absolute terms...

 

But, each time SPY's implied vol has compressed this low relative to HYG's implied vol (remember both very much a risk-on assets) - there has been a decompression in vol AND a drop in equity prices...

 

Charts: Bloomberg