Inside Markets — Pain Trade

The main catalyst for the recent backup in equity markets was the hawkish cut at the October Fed meeting.  Whether the Fed cuts rates in December or waits until January shouldn’t materially change the outlook for equities priced on future cash flows over ~10 years, but it does impact near-term risk sentiment.  Market-based probability for a December rate cut swung from ~80% before the October meeting to as low as ~20% last week and now back to ~80% as of this morning.  The 3-week long risk off environment that followed the 10/29 Fed meeting flipped the seasonal narrative from chasing performance to protecting YTD gains.  Investors also shed a good amount of length during that time as broad equity positioning as of Friday had fallen back below neutral. Implied equity volatility (VIX) closed at 26.4 last Thursday, which is above ‘elevated’ levels (>22) that tend to be a headwind to rally attempts.  This morning, the VIX has returned to a more benign reading below 20.  Sustaining VIX levels below 20 with improved risk sentiment and neutral positioning would have the pain trade aimed higher again into year-end.