Last week, we discussed the latest Goldman trading desk note according to which "everyone is now hedged for a crash", with the bank indicating that the market was averaging $1 Trillion worth of puts per day, the "largest on record" and adding that there has been several days where put notional set even higher daily records: "Monday for example $2.2 Trillion notional traded in US options market, with 64% puts ($1.4 Trillion) further adding LP hedges and taking the street further short gamma."
Why is this important? Well, besides our conclusion that acute downside to stocks is now limited as everyone who wants to be is hedged, overnight Sundial Capital Research picked up on this observation writing that hedging on U.S. stocks has risen to the highest level in almost two years, and reached a point that usually precedes equity gains.
“The behavior of scrambling for hedges across various products is a new development,” Sundial’s Jason Goepfert wrote in a note on Monday adding that his equity-hedging index climbed above 80% last week for the first time since early April 2020, he said, and “this is only the 33rd week in 22 years that it’s been above that threshold. After 27 of those weeks, the S&P 500 rallied during the next couple of months.”
That said, the surge in put buying is at best a short-term reversal indicator, and Goepfert concedes that “almost every metric we watch is in negative territory, and investors are in risk-off mode. That is not a great combo,” he said in the report. “The only potential saving grace is that pessimism reached a high level,” with aggressive hedging -- and “even in unhealthy market environments, that’s usually enough to generate a multi-week to multi-month rebound.”
Taking this level of inquiry one step further, on Monday, in the latest weekly bullish sermon from JPMorgan (which we mentioned in passing alongside Morgan Stanley's latest fire and brimstone weekly note), the bank's chief equity strategist Mislav Matejka made a handful of (rather trivial) bullish observations such as the following...
- We believe that equities still offer upside, and that the cycle is far from over [of course you do since you keep saying BTFD every week]. We look for more gains in earnings, bottoming out in China activity, after being cautious onthe space last year, and expect the Fed not to turn ever more hawkish, relative to what is currently priced in.
- We think it is wrong to position for a recession given still extremely favorable financing conditions, with real rates at -70bp, very strong labor markets, unleveraged consumer, strong corporate cash flows, strong banks’ balance sheets, as well as the turn for the better in China policy outlook. COVID impact should be fading further, with the Omicron variant proving to be milder than the prior ones. This should help stabilize consumer confidence, and show a bounce in mobility indices.
- There are signs of supply constraints passing their worst point, and of power prices surge easing. Geopolitics could heat up again in 2nd half of February, but we expect any military escalation to be localized and short lived, producing another buying opportunity.
... but what was most notable is JPM's own analysis of how the recent manic surge in put buying has translated in a surge in the VIX, and what happens after.
According to Matejka, "investor sentiment has become too negative of late, as evidenced in Bull-Bear moving to lows of the range, and equity index RSIs becoming oversold recently", but more importantly, one should use volatility as an opportunity to add, as the VIX has produced a buy signal.
Why? Because after a spike in the VIX - such as the one experienced in recent weeks - " equities have tended to move up 100% of the time over the next 1 and 6 months."
As the table below shows, the VIX signal has been triggered 21 times since 1990, with the S&P 500 Index gaining an average 9% in the six months afterwards. Prior to January, the last time the indicator flashed was in November, and since then global stocks have tumbled.
So buy stocks right? After all, if there is a 100% hit rate on a 9% bounce in stocks what's not to like? Well, there is one caveat, and it's a pretty big one: As Matejka puts it, the VIX buy signal works 100% but only outside of recessions.
In other words, if we are indeed headed for a recession as we have been arguing for weeks, this entire thesis is meaningless (and has a hit rate of 40%, less than a coin flip). Of course, if we are indeed in a recession that means that it's only a matter of time before the Fed - kicking and screaming as Biden threatens to repeatedly sniff Powell's hair if he unleashes even more approval-rate crushing inflation - is forced to ease aggressively.
Which, ironically, would be a far more bullish signal for risk over the medium- to longer-term, because once the current recession is widely recognized even by the Mandarins in the Marriner Eccles building, the Fed will have to go all in on stabilizing not just the economy but also markets, especially since after the midterms which the GOP will win in an avalanche removing any hope of more fiscal stimmies for years...
... the only possible stimulus until 2025 will come from the Fed.