As the VIX continues its downward trend since March, now resting at 13.61, one can't help but question the rationality behind this seemingly calm market landscape. Despite the tranquil façade, there is a storm of uncertainty brewing underneath, and I argue that a surge in volatility is not just inevitable, but imminent.
In this post, I'll highlight several factors that contribute to this prediction and why you might want to consider going long on the VIX.
Interest Rate Hikes & Inflation Concerns
The Federal Reserve paused the interest rate hikes in its latest meeting but has hinted that future increases are on the horizon. Market forecasts suggest a modest 16% hike in September followed by a 32% cut in December. However, the Fed is indicating that a rate cut in 2023 is unlikely, with a pause and hold scenario more probable. If the market has misjudged the upcoming announcements, this could incite a wave of volatility.
Chairman Jerome Powell has further indicated that maintaining higher interest rates for a prolonged period might be necessary to guide inflation towards its 2% growth target. With the current rate sitting at 4.04%, down from its 9.05% peak in June, we're still "very far" from the target. This prolonged high interest rate environment could distress companies and regional banks, potentially leading to a series of bankruptcies within the next year and generating market volatility.
The Refinancing Problem
Many businesses took advantage of low-interest rates during the Covid-19 pandemic, securing short-term loans to survive. As these loans reach their expiration within the next year, they will need to be refinanced under significantly higher interest rates. The increased borrowing cost could push distressed companies towards bankruptcy and negatively affect their stock prices, thereby causing market jitters and a potential surge in the VIX.
Hedge Funds & Market Indicators
According to Goldman Sachs' prime brokerage, hedge funds have been selling off for nine out of the past ten days. Notably, the MACD (Moving Average Convergence Divergence) of the VIX, currently at -0.96, has seen its downward momentum stalling since June 8th. With the MACD a mere -0.034 off the signal line, a bullish crossover seems imminent, potentially attracting momentum futures traders into the game.
Simultaneously, the S&P 500's MACD, currently sitting at 6.04 and trending downward towards a bearish crossover, could indicate a potential market correction. The MACD levels are reminiscent of those in early February, which was followed by a 9% market drawdown before a recovery driven by mega-cap tech companies. However, this rally appears to be stalling out now.
The Bull Run Paradox
Despite the underlying uncertainties, the market continues its bull run, an event I find puzzling and perhaps a bear rally in disguise. If this is the case, an ensuing drawdown could spark a panic, causing volatility and a subsequent rise in the VIX.
Currently, the VIX sits at levels last seen before the initial COVID-19 outbreak in 2020, likely due to the ongoing S&P500 bull run. However, a mean reversion could be on the horizon, offering a buying opportunity for the VIX. It's not unfathomable to anticipate a return to the VIX levels seen in May, marking a rise between 12%-30% off its current position.
The Seasonality Factor
Historically, the VIX tends to fall in H1, rises in H2, and then declines late in the year during the holiday season. As we move into H2, a seasonal rise could be in store. This increase might be further propelled by Q2 earnings, particularly if companies dial back their optimistic outlooks voiced during the Q1 earnings season.
Given these numerous uncertainties, the current market appears overly confident, possibly setting us up for an impending volatility spike. If this prediction holds true, we could witness a considerable surge in the VIX between now and October, presenting a promising trading opportunity.
Note: Although 9823 Capital is a registered investment advisor, this is NOT INVESTMENT ADVICE. It's simply my observations and readers should do their own research and come to their own conclusions.
