The Era of Low Volatility Will Unwind Formulaically

Dean Curnutt, founder of Macro Risk Advisors puts today’s low vol climate into context in this piece, which was also published on BloombergView. In this piece he discusses the way in which the shattering of a strong degree of market consensus lies at the heart of risk-off events.  With that in mind, he looks at what the means for today’s asset prices. 1) He argues that the probability of a recession is low, corporate earnings will grow and the S&P 500 will continue to rise. Both model and surveys driven approaches generally forecast a recession probability of less than 15% the next 12 months.  Among the 8 strategists that have submitted year-end 2018 price targets on the S&P 500 to Bloomberg, not one forecasts a decline in the index over the next year. 2) Inflation and interest rates are low and stable, and with high confidence, markets believe they will remain that way.  Inflation options imply only a 16% chance that CPI will exceed 3% over the next year.  The MOVE index of interest rate implied volatility just reached an all-time low. 3) Geopolitical risk poses little threat. Implied volatility on the Korean won has receded to levels not observed since 2014 as investors shrug off heated rhetoric between the US and DPRK. 4) Equity market volatility is low and will remain that way.  VIX option prices imply just a 12.5% chance that the fear gauge will be above 20 out three months. 4) Return correlations, both among equities and between stocks and bonds will continue to be very low, serving to reduce overall portfolio risk. If you’d like to read samples of MRA’s coverage on risk management and vol markets, they are happy to provide. Click below.