* VIX close to record low despite high political uncertainty.
Commensurate with the S&P moving to all-time highs, the VIX has fallen below 12 and close to an all-time low. However, such a low level of ‘fear’ in equity markets looks very unusual when compared to the heightened level of political uncertainty that exists today as these two series have traditionally, and logically, tracked one another closely. If the recent spike in policy uncertainty normalises soon, then this current disconnect is not particularly worrisome for markets; however, such a scenario strikes us being rather optimistic.
* Investors are significantly short the VIX despite its very low level.
Despite the fact that the VIX is already very low versus history, speculators appear to be positioned for further declines in volatility. CFTC data shows that speculative positioning on the VIX has reached a net short of over 22% of open interest, the lowest level in three years. A trough in this speculative positioning series usually coincides with a tactical peak for markets.
* The current sub-12 VIX reading has been a good warning sign for European stocks in this cycle. The first chart below illustrates the subsequent performance of European equities based on the starting level of the VIX. Since 2010, when the VIX has been at similarly low levels as we see today, this has provided a good warning sign for European equities. Over both the subsequent one and three months, European equities have on average declined by 2% following a sub-12 VIX reading. When the VIX has been below 12, European equities have only delivered positive returns 14% of the time over the following one month, and delivering positive returns just 24% of the time over the following three months.
* Investors are 2SD net long US equities and Treasuries.
With the exception of Hedge Fund positioning, which remains subdued, and mutual fund flows to Europe, which remain very weak, the majority of sentiment indicators look elevated. In addition to the low levels of volatility, our Global Risk Demand Index (GRDI) is above +1 standard deviations and the DAX recently hit an RSI of >70. Unusually, CFTC data shows that there is a 2 standard deviation net speculative long position in both US equities and treasuries, an occurrence only seen three times in the past 30 years (in 2000, 2006 and 2012).
* Last month saw the highest breadth of high beta outperformance since 2012.
The recent rise in sentiment metrics has been accompanied by a strong rally in the high beta segment of the market. We calculate that 87% of high beta stocks in Europe (i.e. stocks with their 3Y beta in the top quintile of the market) have outperformed over the last month, the highest level since January 2012. We have seen this metric rise above 80% only three times in the past (Apr-09, Mar-10 and Jan-12) and the latter two periods have coincided with market peaks. Logically, low beta stocks continue to lose steam with only 28% of stocks in that cohort outperforming the market over the last month, also the lowest level since January 2012.