“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”
In investment, when everyone is pointing in the same direction, like sheep, it is normally the wrong direction. So, when I read a few days ago that “Hedge Funds are shorting the VIX at a rate never seen before[1], I was incredulous. The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market’s expectation of volatility as implied by S&P 500 index options, and is commonly referred to as the fear index or the fear gauge. High VIX readings mean investors see significant risk that the market will move sharply, either downward or upward and low VIX readings the opposite. Hedge funds shorting refers to when they sell an asset they have borrowed, hoping to profit from a subsequent fall in the price of the asset. One might therefore, expect to short something after it had just shot up or was anomalously high, just before the laws of gravity set in.  However, as the VIX chart below, the index is quite low today by historical standards – we have calculated that the monthly average since the end of January 1990 has been 19.3x vs the current level of 13.4x, suggesting today’s levels are over 30% below average.
Vix graph
And yet speculators, mostly hedge funds are apparently short in a level not seen since records began in 2004:
VIX Futures
Presumably, these hedge funds are betting on markets becoming more euphoric and less volatile. However, markets are already healthy with almost every asset class producing positive returns so far this year:
Assets performance YTD
Moreover, the worries that led to higher volatility and more subdued markets last year could easily return.  In particular:
  1. In the UK, Brexit continues to remain unresolved with potentially widely divergent economic and political outcomes, and potential spillover effects on the European markets and economies.
  2. US/China trade talks are reaching an inflection point, with the Chinese team set to return to the US next week to continue talks.
  3. Recent economic growth has been positive with better than expected Q1 GDP reading for the Euro Area at +0.4% quarter on quarter (vs. +0.3% expected).  The US continues to grow strongly but the April PMI (Purchasing Managers Index) recently fell to 52.6, the weakest reading since January 2017.
  4. World trade volumes are falling at the fastest rate in a decade[2] with Bloomberg estimating a 1.9 percent drop in the three months to the end of February compared with the previous three months, the steepest drop since the period to the end of May 2009.
World trading volumes
My own view as CIO at SCM Direct, is to try and replicate the thoughts of Warren Buffett that you should “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” i.e. a low VIX index should make you nervous rather than complacent. Our reaction to the latest general euphoria is to look to slightly reduce our portfolios exposure to equities, after their sharp recent rise, and to steer the equities exposure towards some of the more out of favour areas e.g. South Korea or Japan rather than US equities or tech and to look at tilting towards more value rather than growth stocks, after their recent underperformance:
Index earnings
Source: Bloomberg LP

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