VIX Positioning Flips Net Long; Seasonality Signals Dotcom Repeat

If the Trump administration and Wall Street needed any further reminders that the current economic environment is rapidly changing, they got it through a shock of volatility in October, with the S&P 500 experiencing one of its worst months since September 2011.

The S&P 500 has broken below its 9-year recovery channel…

The VIX term structure has now been inverted for 20 days straight… the longest streak since August 2011

And Nasdaq VIX is at its highest relative to the S&P since 2004…

And as economic policy uncertainty begins to re-accelerate, so does equity market uncertainty (though VIX remains notably under-priced)…

In other words, today is the rare moment in time when fundamentals and technicals are coming together and warn about a turning point in markets. It is likely that a worldwide slowdown is here and it will soon show up in US economic data, thus why Wall Street started to derisk last month.

Reuters confirmed this changing environment on Friday when speculators’ positions in Cboe Volatility Index VIX swung to a net long for the first time since May, per the latest U.S. Commodity Futures Trading Commission (CFTC) positioning data:

  • CFTC data through Oct. 30 show speculators net long VIX futures at 1,998 contracts, compared with a net short position of 10,303 contracts a week earlier

  • Overall open VIX futures volume was little changed at 504,037 contracts, close to the highest since early February

  • A sharp sell-off for U.S. stocks in recent weeks has pushed up volatility on Wall Street

With CFTC data showing speculators net long volatility, the seasonality chart below could point to even more instability for the remainder of the year. A move that would surely bankrupt the Target manager who made millions of dollars shorting the VIX in “accommodative times,” but as we know, Fed chair Powell recently removed that word from Fed communication pieces.

Of course, for now, hope remains that midterm election uncertainty will unleash a buying-panic (assuming for some reason that this recent selloff is related to the midterms)

As Deutsche Bank explains, the base case is the Democrats taking over the House and holds the potential to reduce downside risks from trade policy friction. We see a variety of possible channels through which the administration’s agenda on trade is likely to be curtailed by a switch in majority. Congressional investigations and potential impeachment proceedings, even though nominal, would likely use up significant bandwidth while a growing number of Democrats and even Republicans are likely to attempt reducing Presidential power in dealing with trade. If trade frictions reduce, that allows the market focus to shift back on strong US growth; and also ease pressure on global growth and in our view would lead to a stronger eventual rally. The market is currently pricing in almost no growth implying significant scope for a catch up rally.

If Republicans keep control of both the House and the Senate that would be interpreted by the administration and the market as public support for the trade war, likely leading to further escalation. In the very short term while the market might rally due to the aforementioned base of investors who attribute strong growth to the Republicans’ policy, we think it prolongs the period of trade uncertainty and hurts growth.

No matter the result, the record net short bond position continues to collapse despite widening yields this week after equity’s biggest short-squeeze since the post-Brexit bounce…

With that being said, VIX 2018 could be following the footsteps of VIX 2000.

History does not repeat but instead could rhyme…

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