Low Treasury Volatility Is Key to Equity Rally, Tallbacken Says
(Bloomberg) -- Investors should be alert to risks for the stock market from any significant increase in a gauge of U.S. bond volatility, according to Tallbacken Capital Advisors LLC.
The ICE BofA MOVE Index, a measure of implied volatility in the Treasury market, is near September’s record low. That suggests confidence in the Federal Reserve’s ability to becalm U.S. sovereign bond yields, providing a bedrock for elevated equity valuations.
While the reading also signals that markets view the outcome of the U.S. election as relatively benign, the index should be monitored closely given that some major stock markets are around all-time highs, Tallbacken Chief Executive Officer Michael Purves said in a phone interview.
“Equities sit on the foundation of the bond market and if that foundation is unstable, the equity rally is more unstable,” Purves said Monday. “If the MOVE were going into a much higher range it would put pressure on volatility.”
Global stocks have surged about 72% from the worst of the market turmoil in March last year sparked by the pandemic. The jump has stretched valuations, triggering concern that investors may have already seen the best of the rally. Risks include the pace of vaccine distribution and uncertainty over how much of President-elect Joe Biden’s $1.9 trillion Covid-19 relief plan will be implemented.
If the MOVE index rises significantly, that starts a “very different” conversation about the health of the equity market, Purves said, because if yields are going to start jumping, stock valuations could contract significantly.
But he expects the very low MOVE gauge should eventually create a “gravitational pull” on the Cboe Volatility Index, or VIX, a measure of implied equity swings for the S&P 500 index.
“I do think we will get below 20 at some point soon but it’s probably not this week or the week after,” Purves said, referring to the VIX. “The premium of implied to realized volatility is crazy high. Volatility sellers should come in and sell this, but I think they’re kind of nervous, since there’s a fair amount of political risk and we’re still in a pandemic.”
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