In July, the market’s most commonly used measure of volatility, the VIX, plunged to a 23-year low of 9.04, the lowest level since December 1993. As Reuters pointed out at the time, if the index had closed at this level, it would have been the lowest close in history. The lowest level ever recorded was 8.83 in December 1993. Are we experiencing irrational exuberance? Maybe not.
Since July, barring one jolt in August when it hit 16, Wall Street’s ‘fear gauge’ has remained below 14, significantly below its long-term average of 20. Some analysts have claimed that the depressed volatility is a sign of just how complacent investors and traders have become with the market, which seems to lack any direction.
At the end of August, JPMorgan Cazenove’s Mislav Matejka claimed that “the near-term risk-reward has turned less attractive” for equities as “sentiment has turned complacent.”
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However, Nomura analysts Sam Bonney and Bilal Hafeez disagree with this view. In a research note out today the duo argue that the market is currently "comfortable, not complacent" as key measures "do not suggest excessive levels of exuberance."
Key Measures Of Exuberance Don't Show Complacency
The analysts cite three key measures as not pointing to exuberance. Firstly, ‘Intellectual positioning’ is not heavy as there is no "clustering of consensus forecasts," which typically happens "happens around a benign outlook, and is a sign that participants are extrapolating current positivity further and further into the future." Heavy intellectual positioning can make investors more vulnerable and more sensitive to a shift in the outlook -- a sudden shift in expectations can result in violent market reactions.
Second, equity inflows have accelerated alongside fixed income. Equity inflows tend to be well correlated with activity data and have recently accelerated with the economic upturn we have seen. Meanwhile, positioning data into USTs also suggest participants have significantly increased long positioning in US 10yrs. Net long positioning currently stands at 19% of outstanding contracts, a significant reversal of the 29% net-short positioning seen in mid-March. As exuberance is usually accompanied by a great rotation into risk assets, this flows data shows that investors are far from complacent, if anything they're only just starting to return to equities in a big way.
Nomura's analysts point out that one major argument against complacency is the recent economic data that continues to indicate too high growth momentum. What's more, "low inflation and unusually high levels of monetary accommodation suggest there is still further cyclical space in this business cycle."