Even though the threat of pervasive selling of volatility was generally ignored by the financial community and broader public, at least until Monday's historic VIX surge when a cascading short squeeze amid the inverse VIX ETN community unleashed the biggest VIX buying order in history also called "volmageddon", there were many who warned about the potential threat that the one-way VIX short pile up has created: among them were Barclays, Goldman, Morgan Stanley, Fasanara Capital, Peter Tchir, Kevin Muir... as well as SocGen's Roland Kalyoan.
Last November, Kaloyan warned about the risks of overcrowded short positions on volatility. In his Nov. 23 note, the SocGen strategist wrote that he was “less enthusiastic” about equities in 2018 and warned that the number of short positions on volatility could “potentially strongly deteriorate the risk reward profile of equity markets" to wit:
We are less enthusiastic about equities heading into 2018 – We do not see much upside on our major equity targets for the next 12 months. We expect stretched valuations and rising bond yields to limit equity index performances in 2018 and the prospect of a US economic slowdown in 2020 to further cramp returns in 2019. We also raise some concerns about the quantity of shorts on volatility, which could potentially strongly deteriorate the risk reward profile of equity markets.
Two months later that's precisely what happened.
Fast forward to today, when he has a similar downbeat message to investors: "don’t even think about buying the stock dip." Why? Because it was never about vol: that's just a symptom of all traders being on the same side of the trade, instead it's all about the 10Y, something we showed earlier today when we observed the sharp adverse reaction to the 10Y yield spiking back over 2.50%.
“Equity investors have had an amazing time over the past four-five years,” Kaloyan told Bloomberg in an interview. “But now, the surge in bond yields is reaching the pain threshold for equities.”
As a reminder, it was the 10% hitting 2.85% last Friday that launched the 666 point Dow Jones dip (followed one day later by a crash nearly double the size). It was also the 10Y's reaching 2.85% earlier today that halted the surge in the S&P.
Rising bond yields is set to put pressure on already-stretched stock valuations, he said. “With the 10-year Treasury yield reaching the zone of 2.5 percent to 3 percent, it means that fixed income becomes attractive again when compared with equity dividend yields.”
Kaloyan also said investors should "not be fooled by robust corporate earnings momentum as analysts rush to upgrade profit forecasts in part to reflect the tax reform, because the market has already priced in all the good news on that front."
To be sure, one can counter that Kaloyan has merely become exceptionally bearish: after all this is how we introduced his 2018 outlook back in November: "Get Out Now: SocGen Predicts Market Crash, Bear Market For The S&P."
But it's not just Kaloyan: another warning comes from an analyst who until very recently was an unabashed permabull, Morgan Stanley's chief equity strategist Mike Wilson, who last year had the highest price target for the S&P. Wilson has joined a growing chorus of warnings to get out and not buy the dip, and in a note released this week, wrote that he expects "further downside in the near term as markets continue to digest shocks... This should take several weeks however and we are in no rush to buy this dip as we wait for better technical signals."