While the reopening of the US economy has given investors to hop on the rally in big-tech, current levels of market volatility point to signs of caution.
Often referred to as Wall Street’s “fear gauge”, the VIX is an instrument that reflects equity market volatility derived from the price inputs of the S&P500 index options. As equity markets rally and darlings like Tesla and Amazon hit record highs, the VIX remains 40% its historic average, at nearly 28.
Well below the high it struck during sharp market fall in late March, elevated levels of the VIX indicate that investors are still bracing for potential shake-ups in equity markets. Often used as a hedging instrument, the VIX tends to move inversely against major moves in equity indices.
However, the VIX isn’t the only instrument displaying signs of investor caution. Capital inflows to the safe have assets like bonds and gold tell a similar story.
Yields on US treasuries, which move inversely with respect to bond demand, sit near record lows. For instance, the yield on the 10 year US bond currently yields 0.62%, while the 30-year bond yields 1.31%. Additionally, gold prices have rallied over 18% for the year and hit an eight-year high on Tuesday.
Investors are witnessing a greater divergence between technology stocks and the broader market. Add to that the possibility of a second wave of COVID-19 and weak fundamentals, elevated levels of the VIX reflect increased hedging cost when managing portfolio risk.
Passive investors may choose diversification and risk management tools with diversified ETFs or VIX related ETPs (exchange-traded products). However, the fallout since March lows may make the choice harder as major VIX related ETFs were shut down because of accrued losses.
Credit Suisse closed nine leveraged ETFs, including the TVIX, the world’s biggest volatility exchange-traded product. The sell-off markets witnessed earlier this year sent the TVIX to rise over 206%, increasing total assets to $1.4 billion. No other ETP with assets over $1 billion has ever been closed before.
With the Fed market intervention and market optimism in the tech sector, portfolio hedging needs to be justified not only in terms of its cost, which currently trades at a premium, but also the potential gains investors could make in the equity market rally.