VIX’s Decline Triggers a How-Low-Can-It-Go Debate: Taking Stock

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In a matter of weeks, Wall Street worrywarts have gone from fretting over high volatility to fearing bets on stock swings are falling too fast.

Strategists at Evercore ISI on Tuesday joined calls last week from their counterparts at Tallbacken Capital and WallachBeth Capital who said it’s time to close bets that price moves for the largest U.S. companies will keep falling. The rationale: hospitalizations in the U.S. are reaching record high levels, while the Cboe VIX Index has already dropped to its lowest level since August. Betting on lower volatility at this point may not be worth the risk, they say.

Still for lots of fund managers, the drop in the VIX is clear reason to be bullish. Volatility-control strategies, a type of systematic investing strategy, could plow between $25 billion and $32 billion into stocks over the next three months, according to BNP Paribas SA.

VIX’s Decline Triggers a How-Low-Can-It-Go Debate: Taking Stock

Bets on subsiding price swings in the S&P 500 populated the market late last month, when volatility hovered at 40 and anxiety about a contested election ran high. The next two weeks amounted to half a year’s worth of developments, between Joe Biden’s projected victory, a breakthrough on a Covid-19 vaccine and a reporting season that showed earnings contraction of about a third of what had been expected. That’s prompted a 13-point drop in volatility over seven trading days, a move that still leaves the index well above its five year average, perhaps in consideration that the vaccine news, as promising as it sounds, won’t help with a spike in infections happening today.

“We have to get though a surge in hospitalization rates now before we see a positive effect of the vaccine months later,” Dennis Debusschere, head of portfolio strategy at Evercore ISI, said by phone. “The markets are cheering the vaccine news, but there’s a wall of uncertainty investors are facing in the near-term. This can be a good opportunity to close the trade.”

A broader look at the contour of the VIX futures curve offers another reason to pack in the short volatility trade. When traders put out bets on subsiding swings last month, the curve was nearly the most inverted it had been in decades, meaning traders expected soaring near-term volatility and a steep decline later. Anywhere you look on the futures curve now, the dots are hovering at or near 25. In other words, volatility is expected to stay at the same level later in November and eight months from now. That’s about where the VIX Index closed on Tuesday.

VIX’s Decline Triggers a How-Low-Can-It-Go Debate: Taking Stock

“The VIX curve remains stubbornly, remarkably flat pretty much the whole way out,” said Steve Sosnick, chief strategist at Interactive Brokers. “It’s more or less 25 until the summer. I understand why there are buyers of those puts - it’s hard to expect vol to stay that high - and I also understand why some firms are giving up on the trade.”

So far this morning, markets aren’t cooperating with the calls to exit a short volatility trade, with the VIX trading lower and futures higher across the board, following gains in Europe’s Stoxx 600 Index and defying a drop in most of Asia. Premarket gains are being led by tech futures, up 1.1%, although value names like Carnival Corp, Boeing are also in the green, contributing to a 0.8% gain in S&P 500 futures.

Notes From the Sell Side:

American International Group was downgraded to neutral from buy at Goldman Sachs, which cited valuation following a recent advance, writing that “a considerable portion of the upside” it had expected was now priced into the stock. Shares up more than 40% off a September peak, with recent gains coming on AIG’s third-quarter results. Analyst Yaron Kinar sees “limited upside” to Goldman’s new target, though “with the continued turnaround of the company’s P&C operations and with P&C rates at its back, we believe that downside is capped as well.”

Yelp was upgraded to outperform from in-line at Evercore ISI, which expressed optimism about the company’s ability to recover from pandemic-related weakness. The firm expects “Yelp’s revenue recovery to track the proliferation of vaccines” and added that there was “good reason to believe that it can recover faster than the broader travel industry.” The stock has a “clear path towards both multiple and estimate upside from here,” it wrote.

Datadog was downgraded to neutral at JPMorgan, which cited the software company’s third-quarter results. This was “the second straight quarter of deceleration for a company that has been trading north of 40x revenue,” and that slowing “is likely to cause pressure to the stock,” the firm wrote. It added that while revenue growth should remain above 30% for the next two years, “we expect valuation to normalize,” keeping the stock’s performance more in line with peers.

Sectors in Focus:

  • Watch ride-hailing companies after Lyft reported third-quarter revenue that topped estimates. UBER may react.
  • Watch TV networks and broadcasting providers after FuboTV boosted its fourth quarter revenue and paid subscriber forecasts. The stock is up 22% before the bell. Stocks like MSGE, AMCΧ, DISCA, FOXA may react.
  • The maker of data-monitoring software Datadog tumbled after an estimate-beating revenue forecast failed to satisfy investors that have watched the stock more than double this year. Watch peers like CRWD, SPLK, PANW, NET, FTNT.
  • Watch bitcoin-related names GBTC, OSTK, MARA, DPW, RIOT after the cryptocurrency edged closer to $15,600, the highest since Jan. 2018.
  • Watch chip equipment stocks after Brooks Automation posted revenue forecast that topped the highest analyst estimate. The stock is up 8% before the bell.
  • Watch shares of Alibaba as it holds its Singles’ Day event.
  • Volatility in pot stocks continues, with Aurora Cannabis sliding 16% premakret and Tilray falling 4% before the bell - after advancing 142% and 69% last week, respectively.

Tick-By-Tick to Today’s Actionable Events:

  • 6am-- APD earnings
  • 6am-- DOYU earnings call
  • 6:30am-- GIB/A CN earnings
  • 7am-- MBA Mortgage Applications
  • 7am-- ADNT earnings
  • 7am-- HUYA earnings call
  • 8am-- POW CN earnings
  • 8:30am-- MCFT earnings call
  • 8:40am-- OPEC issues monthly oil market report
  • 1pm-- Marathon Asset Management Chairman & CEO Bruce Richards on Bloomberg TV
  • 4:03pm-- RVLV earnings
  • 5pm-- MFC CN earnings
  • Recent IPOs reporting post-market: REYN, PTVE, VRM, OM, GOCO
  • IPO lock-up expiring: ADCT
  • BABA holds Singles’ Day event

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