Positioning, Sentiment and Volatility
March 22, 2022
Light positioning and extreme bearish sentiment keeps near-term equity market risk skewed to the upside. The usual internal signals that appear toward the end of a bullish phase weren’t present in the runup to the January correction. The magnitude of the January correction falls into the midpoint of those preceding the last 4 Fed tightening cycles. On the rebound from January lows, we previewed that corrections experience a retest roughly 50% of the time and roughly 50% of successful retests include a shallow (1%-2%) break to new lows. That’s just the way markets make bottoms. Our patience on the rebound also followed a January 5th spike in realized equity volatility when the VIX broke above 20. Increased equity volatility adds a significant headwind to rally attempts, and usually takes a few months to dissipate once it escapes containment. Russia’s invasion of Ukraine increased realized volatility with the VIX spiking to 36.45 on March 7. The VIX broke below 30 after the 3/16 Fed policy announcement partially removed the uncertainty discount from early January. The VIX has declined to 22.84 today as markets get comfortable with Fed tightening and anticipate some eventual resolution in Ukraine. A sub-20 VIX wouldn’t be a catalyst but should signal an easing of the volatility headwind that’s lasted nearly 3 months.