Realized volatility in the US equity markets has been extremely low, and much discussed, but, as Deutsche Bank's David Bianco warns this is "the quiet before the storm." There are five catalysts for increased vol through Autumn but most worrying is the "High P/E, Low VIX" scenario is very risky having reached "mania" levels.
Current volatility is a poor indicator of future risk: High PE / low VIX very risky
The standard deviation of annualized daily S&P price moves has been 6% since August started.
The lowest 30 day+ vol since Aug-Sep of 1995 and versus a 14% monthly average since 1960. Only 1964, 1993 & 1995 had vol at such low levels for more than a few months and these are the only three years the S&P didn’t suffer a 5%+ dip from its one year high.
Dips of 5%+ usually occur twice a year. 2016 had 2 dips already and we expect another soon.
Unlike the straight-up halcyon years above, 2016 is later in the cycle with 0% S&P EPS growth vs. strong double-digit growth in those years.
Post recession normalizing Fed hikes were behind by 1964 & 1995. 1964 was an election year, but LBJ was an in place successor. Current volatility is a poor indicator of future risk. It has a long history of mean reversion and is prone to sudden spikes. Our fundamental assessment of S&P risk puts it lower than 2008-2012, but not below long-term history. We take concern with this very low vol amidst low volume and high PEs.
One of our favorite risk sentiment indicators, which we use in a contrarian fashion, the PE/VIX ratio signals a very complacent market.
It has not ended well…
Deutsche sees five catalysts to increased volatility this autumn:
1) analyst btm-up 2017E S&P EPS cuts during 3Q reporting,
2) no Fed hike in Sept with no clear explanation as to when,
3) macro data that suggests an "L shaped" capex recovery,
4) US election and policy uncertainty,
5) PEs fully dependent on low bond yields at bond substitutes and also at cyclicals, like Energy & Industrials, when low yields should be a greater benefit to PEs at non-cyclical growth sector like Tech & Health Care. Near-term we favor Utilities & Telecom over Financials. We favor lower PE mega-caps.
Hiogh P/Es typically come with higher volatility and more dips…
We doubt equity volatility stays low, we think an 8-10% S&P decline looms.