Will The Market Shock Escalate Further: It Depends On Just One Thing

The great, and record VIX eruption of February 5 may have come and gone - or is at least dormant for now in the aftermath of the great VIX ETP extinction event - but that does not mean it won't come back: in fact as Goldman's new head quant wrote overnight, the bank's clients had just one recurring question in recent days: "do i have to worry about another volatility spike."

While Goldman answered in the context of the vol complex, where things have certainly eased down substantially since the record Vega prints from last week...

... there is another, potentially far more violent storm brewing, and it has little to do with equities.

In a note from BofA's X-asset hedging team published overnight, the bank's strategist Jason Galazidis writes that while the muted cross-asset risk shows the equity shock was largely technical, there is one indicator that may confirm it is not only returning, but is set to spread to all asset classes.

Here is BofA's framing of the narrative that has been on everyone's lips for the past two days.

The sell-off in global equities and in particular US large-caps precipitated an unprecedented jump in S&P implied vol. Notably, the 8% decline in the S&P from late Jan to 6-Feb has already registered as the 10th largest drawdown since 2006. As an indication of how concentrated the shock was to US large caps, S&P puts were by far the best performer and are now the most expensive hedge across the 34 assets in our screen (Chart 1). We would not expect this to persist as markets calm.

To be sure, cross asset vols and credit spreads have not been immune to the repricing of equity risk, but as we pointed out over the past few days, these reactions have so far been less severe: meanwhile, global equity volatility is currently well above long-term median levels for the first time since the Nov-16 US elections.

In contrast, BofA notes, other broad asset risk measures are comfortably below median with commodity, rates and credit actually hovering near their 1st decile since May-07.

In other words, contagion has thus far been relatively limited, again pointing to a technically driven shock which is likely to fade absent cross asset spillover.

Which brings us to the punchline: with the great equity volquake come and - for now - gone, what one indicator should traders watch to determine if a new market shock is imminent? Here is Bank of America's answer:

We continue to believe that watching rates vol is particularly important to gauge the potential for this to escalate further.

If BofA is right, this may be a problem, because as the following chart of X-asset vols for all 4 main asset classes (Equities, rates, FX and commodities) shows, while equity vol is declining, rates vol is creeping steadily higher.

Comments

Kefeer Haus-Targaryen Thu, 02/08/2018 - 10:51 Permalink

I think the ESF (exchange stabilization fund)and alogo's will land this safely after a bunch begin to short this market; the insiders always profit off of fear.  Then it will be just another "correction" described as "healthy".  Then another melt-up - rinse and repeat until the next game is played.

 

The bigger issue facing the planet, besides Jesus, is the rise of the Muslim influence while the Christian influence wanes - that combo is demonic to the core and we see the global impact of death and destruction to the societies and nations; we need to look only at our own nation (USA) to see what it looks like when we remove the Lord and His righteous ways from the nations institutions and look to Europe as the example of the Muslim influence in a godless Europe.  In 20 years Europe we be totally messed up, no true God and full of demon influences.

In reply to by Haus-Targaryen

TuPhat loveyajimbo Thu, 02/08/2018 - 11:39 Permalink

Even if it was mythology it still holds sway over millions of people.  You need to learn the difference between religion and mythology.  Mythology is something people used to believe but no longer do.  The religions of today still have many adherents and that makes a difference in what goes on in the world even if you don't believe.  You seem to be the nutcase here and I hope you can overcome that.  There is a god and your disbelief won't change that.

In reply to by loveyajimbo

Kefeer loveyajimbo Thu, 02/08/2018 - 12:39 Permalink

You are speaking of the BIBLE I assume and I assume you have more than half of all knowledge to prove beyond a doubt that any creature living in a creation has no creator?

 

I'd bet the house you have never read the Scripture nor considered the mathematical fact that the chances of Jesus not being who he claimed to be is in fact zero percent. 

Just fulfilling 7 prophecies would be equivalent to filling Texas 1 foot deep with silver dollars and marking one of them blue and having you blind-folded and told to pick the only blue one.  He fulfilled more that 100...but just use 7 to make that statistical point.  You are the lost sinner headed to hell unless you repent and believe the truth concerning yourself and God. 

You have greater faith than I do in whatever you believe since it cannot be based on knowledge.

In reply to by loveyajimbo

itstippy buzzsaw99 Thu, 02/08/2018 - 10:04 Permalink

Yes.

Excessive leverage used to be the exclusive territory of hedge funds.  Risky business: potential for outsized gains, offset by risk of outsized losses.  Economists insisted that hedge fund players were big boys with very deep pockets who understood the risks and posed no systemic danger should financial markets go pear shaped.  

In today's "reach for yield" environment there are many formerly-conservative investors, both institutional and Mom & Pop, who are way overleveraged.  The massive infusion of "money" and ultra-low interest rates policies from the Central Banks made leverage irrisistably alluring.  Now we have an environment where a 5% drop in the S&P or a .5% uptick in borrowing costs causes major concern across the board.

"Systemic risk" - you don't hear that term used very often anymore.  Dodd-Frank is supposed to have eliminated it.  It's still there, and bigger & badder than it was before the Financial Crisis.

In reply to by buzzsaw99

exartizo Thu, 02/08/2018 - 09:37 Permalink

"they want volatility? we'll give them volatility. Just please come back and play in our sandbox. our toys are bigger and more fun than the crypto sandbox toys any day."

TheSkipper1967 Thu, 02/08/2018 - 11:44 Permalink

You smell that? Do you smell that? Napalm, son. Nothing else in the world smells like that. I love the smell of napalm in the morning.You know, one time we had a hill bombed, for 12 hours. When it was all over, I walked up. We didn't find one of 'em, not one stinkin' dink body. The smell, you know that gasoline smell, the whole hill. Smelled like . . . victory. Someday this MARKET'S gonna end.