Something odd is taking place beneath the market's calm surface: following up on our recent observations of index Skew hitting an all time high, Bank of America's derivatives team writes that even as the S&P has made new highs, volatility markets are not sending the same “all clear” signal. Consider that:
- The VIX has been rising from its 2-Jul closing low of 15.07, even as the S&P 500 has been making new highs, furthering the bank's call that the summer lows for vol are in and the VIX should average in the mid-to-high teens this year.
- Comparing vol metrics across the 12-Jul and 23-Jul S&P peaks, risks implied by S&P options / VIX futures have all risen, particularly in the 1-month bucket vs. shorter (e.g., 1-week) and longer (e.g., 3-month) expiries.
A closer look at the volatility term structure reveals that the S&P options market has begun to price in meaningful event risk around the late-August Jackson Hole Economic Policy Symposium. This risk premium first appeared on 9-Jul following a local low in 10-year US Treasury yields below 1.3%, and has only widened in the last two weeks, suggesting that the S&P options market is trying to price in the risk of a hawkish turn by the Fed at Jackson Hole. This is to be expected: According to the latest BofA Fund Manager Survey, investors expect the Fed to announce a tapering of asset purchases either at Jackson Hole (Aug 26-28, with Powell likely to speak on the 26th) or at the Sep FOMC meeting (22-Sep).
The VIX market is also reflecting increasing concern around Jackson Hole, as seen from the historically wide gap between spot VIX and constant maturity VIX 1m futures and continues to embed a very robust convexity premium (Exhibit 14) to account for still-elevated fragility risk in US equities/equity vol.
Yet despite the market's growing nervousness surrounding Jackson Hole, retail investors could care less and as BofA also points out, the popularity of the “buy-the-dip” phenomenon in US equities continues to rise even as markets are recording near a record number of sudden fragility shocks.
Consider that after the most recent 2-sigma S&P decline experienced on July 19 - the one where Goldman infamously advised clients against buying the dip - the S&P 500 recovered its losses the next day and went on to set a new all-time high by the end of the week.
Quantifying this stunning response, it means that the average recovery time following 2-sigma one-day S&P declines in 2021 is ~2.6 trading days, the fastest recovery since 1928.
As shown in the chart below, of the 20 fastest recovery periods in history, 7 have occurred after the GFC. In other words, since 2008, more than 50% of the time when the market experienced a 2-sigma downside move, it recovered in record time, signalling investors’ willingness to jump into the stock market after contractions
Finally, the strength of the buy-the-dip behavior is confirmed by the downward trend of the recovery periods, reaching a new all-time low this year.
The above is self-explanatory, and the only thing we can add is that in a centrally planned "market" where the Fed has effectively outlawed drawdowns, corrections and - heaven forbid - bear markets, the only trading strategy is being the first to buy the dip, any dip.