With VIX at its 2nd lowest level weekly close in history, amid storms, quakes, dismal data, oh yeah and nuclear armageddon looming, it is perhaps no surprise that speculators sold more VIX futures last week... to a new record level of shorts...
As Reuters reports, the long stretch of low volatility for U.S. stocks has made betting on continued calm a popular and lucrative trade, but traders and strategists warn that risks to the trade have mounted, while the potential for profits has shrunk.
Some traders, however, have grown more wary of increased risks to the trade.
“I think a lot of folks have gotten lulled into a false sense of security because the short trade has gone so well for so long,” said Matt Thompson co-head of Volatility Group at Typhon Capital LLC, in Chicago.
“We are still shorting volatility but we have an itchier trigger finger.”
Assets under management for the top two short volatility products is at $2.8 billion and their exposure to volatility is at an all-time high, according to Barclays Capital. But the very popularity of the trade has cranked up the risk.
And of course, we all know who ends up wearing it at the end...
Positioning in these products, primarily driven by retail players, may be more skewed to the short side than the broader market where institutional investors hold sway.
“I don’t think the risk is necessarily as big on the institutional side as it is on the retail side,” said Omprakash.
In fact, it seems that only FX options traders are seeing through the bullshit...
Which is interesting since, while the Dollar Index just completed its best 2-week rally since December...
Speculators remain at their most short the Dollar (in aggregate across FX Futures) since early 2013...
And finally, as speculators have never been more levered long of the US equity market, so households are loading up on US Stocks.
As Dana Lyons explains, the percentage of financial assets that households currently have invested in stocks has only been exceeded by the 2000 bubble.
From the Federal Reserve’s latest Z.1 Release (formerly, Flow Of Funds), we learn that in the 2nd quarter, household and nonprofit’s stock holdings amounted to 35.7% of their total financial assets. This is the highest percentage since 2000. In fact, the blow-off phase from 1998 to 2000 leading up to the dotcom bubble burst was the only time in the history of the data (since 1945) that saw higher stock investment than now. You might say that everyone is in the pool.
We’ve talked about this data series many times. It is certainly not a timing tool. Rather, it is what we call a “background” indicator, representative of the longer-term backdrop — and potential — of the stock market. It also serves as an instructional lens into investor psychology. For these reasons, it is one of our favorite metrics pertaining to the stock market, as we wrote in a September 2014 post:
“This is one of our favorite data series because it reveals a lot about not only investment levels but investor psychology as well. When investors have had positive recent experiences in the stock market, i.e., a bull market, they have been happy to pour money into stocks. It is consistent with all of the evidence of performance-chasing pointed out by many.
Note how stock investment peaked with major tops in 1966, 1968, 1972, 2000 and 2007. Of course, investment will rise merely with the appreciation of the market; however, we also observe disproportionate jumps in investment levels near tops as well. Note the spikes at the 1968 and 1972 tops and, most egregiously, at the 2000 top.
On the flip side, when investors have bad recent experiences with stocks, it negatively effects investment flows, and in a more profound way than the positive effect. This is consistent with the scientifically proven notion we’ve discussed before that feelings of fear or loss are much stronger than those of greed or gain. Stock investment during he 1966-82 secular bear market provides a good example of this.
After stock investment peaked at 31% in 1968 (by the way, after many of the indexes had topped in 1966 — investors were still buying the dip), it embarked on steady decline over the next 14 years. This, despite the fact the stock market drifted sideways during that time. By the beginning of the secular bull market in 1982, the S&P 500 was right where it was in 1968. However, household stock investment was at an all-time low of 10.9%. If the stock averages drifted sideways, why did stock investment drop by two thirds? The repeated declines over that period left investors scorned and distrustful of the stock market. They never really started putting money back into stocks until 1991.
What is the significance of the current reading? As we mentioned, it is the highest reading since 2000. Considering the markets are at an all-time high, this should not be surprising. In fact, while most of the indexes surpassed their prior peaks in early 2013, household stock investment did not surpass the 2007 highs until the first quarter of this year. The financial crisis put a dent in many investors’ psyches (along with their portfolios) and they’ve been slow to return again. However, along with market appreciation, investor flows have seen at least streaks of exuberance over the past 18 months, boosting investment levels.
Yes, there is still room to go (7.5 percentage points) to reach the bubble highs of 2000. However, one flawed behavioral practice we see time and time again is gauging context and probability based on outlier readings. This is the case in many walks of life from government budgeting to homeowner psychology to analyzing equity valuations. The fact that we are below the highest reading of all-time in stock investment should not lead one’s primary conclusion to be that there is still plenty of room to go to reach those levels.
There are no doubt many investors who are still wary of returning to the stock market due to the two cyclical bear markets in the past dozen years. However, while there may be a certain level of investor mistrust, the moniker of “most hated bull market of all-time” does not seem appropriate. It should not be lost on investors that we are at the second highest level of stock investment ever, behind only the most speculative stock blowoff in U.S. history.”
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