Low Vol, No Vol, 2-Way Vol; It's a Dance to Keep Up
The story of the 2nd quarter was an acceleration of stock market losses, as the S&P officially entered bear market territory, falling as much as -23% from its all time highs at its June 17th closing price.
But this was unlike any new bear market investors have seen in decades, with two unique circumstances hampering investors ability to protect their portfolios. First, bonds failed to provide a buffer, selling off -12.5% (per AGG) alongside equities as rates rose significantly; and second, hardly any bid for Puts below the market, as evidenced by the VIX remaining -10% below its 2022 high despite the new lows in the S&P.
The end result was stocks with their worst start since 1970 and bonds on pace for their worst performance since the Civil War, pushing stocks and bonds to both be down two quarters in a row for just the 4th time in the last 100 years.
It’s as bleak of an outlook as we’ve seen in quite some time, with a recession looming if not already under way, credit spreads widening, and the nasty prospect of higher rates eating up the bulk of corporate cash flows in debt service.
These types of headwinds have historically resulted in the Fed easing rates, but this time around we have a Fed hellbent on rising rates to stop inflation in its tracks despite the prospect of a massive slow down.
How the Fed manages rising rates without dealing a death blow to the US Economy will mean everything for stock prices the rest of the year. Can they navigate a soft landing or not?
The market appears to be pricing in a yes to that question so far, thus the cap on volatility, with traders not bidding over one another to get even more protection.
What happens if the Fed can’t whip inflation into shape without dealing a severe blow? What happens if they overshoot and crush GDP growth and corporate earnings?
It likely won’t be good.
What happens if they’ve already succeeded, we don’t even have a recession, and the market does what it’s done in nearly all its other 1st half swoons, recovering handily…
It’s a two way market now as much as ever.