Inside Markets — Watch the VIX

Crowded long positions have underperformed this earnings season, while crowded short positions have already rallied into the 95th percentile. This leaves Hedge Funds with no easy near-term options other than to reduce leverage. Notwithstanding a spike in implied equity volatility (VIX), we’d expect an SPX pullback to find support in the 5540-5650 range (-3.6% downside to the midpoint). We keep a near-term bullish bias as long as the SPX can sustain closing levels above ~5540, but the index is overbought and due for a pullback with the current ~21.5x forward multiple leaving little room for error. The SPX was able to earn its premium multiple during a prolonged period of subdued volatility. Periods of elevated equity volatility (VIX >22) result in multiple compression as investors demand higher returns (risk premia) to compensate for the increased volatility. Bond market volatility (MOVE Index) is also approaching ‘elevated levels’ with further upside increasing the likelihood that it spills into equity markets. The VIX currently sits at 19.6.