As we described, options market pricing dramatically front-ran the prevailing realized volatility environment, with the VIX hitting the low 40s while realized volatility was still in the mid-80s. In the intervening month, realized volatility has followed implied’s precipitous decline, closing this week at 29.4%.
Short-term implied volatility also decreased modestly over this last month, but found its floor in the high 20s. Interestingly, longer-dated volatility—i.e. the 6th VIX future—is actually up over the month. More on that shortly.
There are, at present, numerous environmental and technical factors that should be supportive of elevated volatility. For example, essentially every economic data point that has been released in the last month has been abysmal; the Department of Labor’s Continuing Jobless Claims last printed 22.6M, a number almost 3.5 times higher than the peak value during the Great Financial Crisis. Other employment measures are telling the same story. Unsurprisingly, Q1 2020 GDP came in at -4.8% growth, quarter over quarter. The U.S. is, of course, not alone in suffering significant economic damage from the shelter-in-place measures aimed at slowing the spread of coronavirus. China printed a staggering -9.8% quarter over quarter contraction for Q1 2020, and forecasts for the UK, Germany, Japan, etc. are also calling for contractions.
Sector-sector correlation within the domestic equity market remains quite elevated, finishing the week at almost 88%, which is a 97th percentile value going back to 2002. In addition, one-month put skew remains quite elevated at 6%, suggesting remaining demand for protection against a renewed equity selloff. As-of May 6th, 86% of S&P 500 companies have reported Q1 2020 earnings, and the blended year over year earnings growth is currently at -13.6%.
We hope the reader takes as axiomatic the assertion that these economic and technical factors would ordinarily imply elevated equity volatility. Thanks to the enormous monetary and fiscal actions from the Federal Reserve and Congress, the equity market has completely disconnected from reality, rallying an absurd 31% from the March 23rd low through May 8th. Again, this bounce is occurring concurrent with some of the worst economic and earnings numbers ever seen. In addition, there is still no viable solution to the coronavirus conundrum beyond shelter-in-place, the ultimate cause of the economic damage the globe is currently coping with. We interpret the longer-dated VIX futures increasing over the month as demonstration that we are not the only asset managers with the view that equity valuations have to catch down to the economy, and not that the economy will quickly rebound and justify current equity valuations.