What the Hell??

One day, big difference.

Friday was a shocker. Out of character with recent market action. Was it a response to a super strong jobs report that may have stoked inflation fears and given a boost to concerns that the Federal Reserve will need to boost interest rates? Was there a leak about Iran lobbing some missiles at Israel over the weekend? Maybe some institutions and hedge funds taking profits in overbought segments of tech? All of the above??

Here’s our what our weekly recap looked like at Thursday’s close. Most equity indices in the green, some teeny declines in bonds and short vol (SVIX) outperforming equities.

What a difference a day can make. Here’s the same table through yesterday’s finish. Equities blood red, bonds down as well and a huge reversal in the vol complex.

Friday’s selling was heavily concentrated in the tech sectors. More defensive areas were able to remain in the green.

The violence of the reversal from Thursday’s calm was on display in the volatility complex. This chart of the CBOE term structure compares Friday with Thursday to isolate the one-day change. Those gaps higher for VIX9D and VIX are both in the 99th percentile of their histories.

The damage in the VIX futures was more muted as the monster move in spot VIX failed to translate into a full move at the front end. The June futures contract still has more than a week to go before expiration and the message here is that futures traders were not convinced that the jump in spot VIX will persist as we move forward. Obviously that remains to be seen.

So what was the impact on the VIX Mix? Bullish to bearish overnight with the largest single day decline (49 points) in the full history of our volatility composite.

Thursday showed 15 bullish components with only one bearish. That flipped on Friday to only two in the green while 15 were in the red. Ten straight sessions with bullish readings wiped out in one fell swoop.

No surprise that the Twittersphere has blown up with posts and tables and charts purporting to predict what happens after such a vicious punch in the face. This one from James Altucher is my fave, in part because he’s controversial to say the least (Google him) and his data set is limited to the last ten years (a full-on bull market). It belongs in the category of “buy every dip because markets only go up.”

Here’s what I think. The monster jump in VIX9D and VIX is indicative of the big shift in option flows to the very short end of the term structure - weekly and daily bets. When fear sets in and investors need to add duration to their hedges, the bid for longer dated options will cause VIX to ‘explode’ (remember August of 2024). As was the case back then, we haven’t seen the VIX futures chase spot VIX higher. Unless and until that happens, we can’t be surprised to see VIX revert back toward the June futures contract as expiration gets closer. On the other hand, VIX holding steady will force the futures higher and that will likely coincide with more pain in equity markets.

Futures markets have just opened as I hit the send button on this post. A little weaker, but no sign of panic at this time. I’ll be back tomorrow with some additional perspective on all this. Friday was just a blip but give some thought to the level of risk you have in your portfolio and make sure you’re comfortable with the potential for a this to be the start of a more meaningful pullback.

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