An unusual drawdown is the perfect ending to an unusual bull market
Head of Equity Strategy
Summary: The current drawdown is soon six months old in the S&P 500 and one of the deeper ones over the past 100 years, but it also one of the more strange drawdowns as the selloff has so far been orderly without panic days. The VIX Index and especially the VIX forward curve have deviated a lot from past observations relative to selloff in 2022. Intraday momentum strategies and a change in investor preference on option protection are two hypotheses behind what we observe. Our argument is that we have not seen the trough yet in S&P 500 and that we need to see the VIX forward curve to invert before we can call it a bottom.
The VIX is stubbornly low relative to selloff
The VIX closed at 28.36 yesterday despite a rather big selloff in the S&P 500. While the average level in the VIX Index has been quite elevated during the entire pandemic it has not reached alarming levels during the drawdown in 2022. We have highlighted it before in our daily Saxo Market Call podcasts and recent equity notes, that the selloff this year has been unusually calm and orderly relative to what we have observed historically.
The VIX forward curve typically inverts (the VIX Index spiking relative to the 2nd VIX futures contract) during market stress or panic, but this time we have not seen that behaviour. Compared to some of the daily moves and the current drawdown depth we have not seen the inversion in VIX which speaks loudly of the unusualness of this drawdown. JPMorgan strategists have recently written about this odd behaviour in the VIX and they argue that the “new structure” has formed over the past two years due to potentially a crowding in intraday momentum trading strategies and a potential shift in option gamma dynamics, with the latter being a function of investors preferring spreads for protection instead of outright puts.
It is ironic that the golden period of 2012-2021, with its brief declines followed by subsequently new and stronger highs due to extraordinary declines in interest rates and higher risk tolerance by investors, is now coming to an end in an unusual way. The market dynamics are very difficult and when combined with the most complex macro environment since the 1970s, many traders and investors have difficulties navigating the market.
Our core thesis is still that inflation will remain higher than consensus and for longer, and that the global economy will eventually slip into a recession. Under higher inflation and interest rates, equities will not come back to its lofty expectations and equity valuations, and thus valuation multiples will continue to act as headwinds on equity returns. We still prefer themes such as commodities, renewable energy, logistics, semiconductors, defence and cyber security.
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Central banks' attempts to kill inflation is a paradigm shift, which could end in a deep recession.
Tangible assets and profitable growth are the winnersWith US equities officially in a bear market, the big question is where and when is the bottom in the current drawdown?
Understanding the lack of investment appetite among oil majorsThe everything rally seen in recent quarters has become more uneven, as its strength is driven by commodities in short supply.
The pressure is on as the wind leaves the sailsWith cryptocurrencies in sharp decline, are we entering a crypto winter or is the bear market a healthy clean-up of the crypto space?
Why the Fed can never catch up and what turns the US dollar lower?Many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve.
Bank of Japan: Swimming against the tideThe Japanese economy has gone from the age of deflation to rapidly rising prices in no time, leaving the Bank of Japan in a pickle.
Green transformation detour and bear market hibernationWith the impending risk of global econonomic derailment, we share the five things investors need to consider in this new half year.
Crisis redux for the eurozone?Whether there's going to be a recession in Europe or not, the path towards a stable economy will be agonizing.
Technical Outlook: Gold, Oil and a remarkable multi-decade perspective on EquitiesThe Nasdaq bubble pattern, USDJPY resistance, crude oil uptrend losing steam and the technical outlook for USD.
China: the train of new development paradigm left the station two years agoChina is transiting to a new development paradigm, as they are hit by deteriorating terms of trade, a slower global economy and an uncertain future while continuing attempts to contain the pandemic.