FAST FIVE: The Last Time This Divergence Emerged, Was Just Before The 2008 Crash
We discussed the collapse in the VIX earlier, when we pointed out that at least according to the world's largest bond manager, this artificial market calm foreshadows another surge in volatility just around the corner, which is also why Pimco's CIO had one recommendation: start selling now.
However, while Pimco may be accused of merely talking their book, there is another empirical indicator which suggests that a violent market reversal may be imminent.
“Despite the increased recession probability, long-dated equity volatility is actually trading lower than in previous years,'' Chintawongvanich wrote in a client note, adding that the vol collapse likely reflects market structure issues (i.e., various speculators selling vol both directly and indirectly) rather than outright complacency.
“In 2007, 1-year vol traded at very low levels despite recession risk having increased rapidly in 2006,” said Chintawongvanich adding that “It was only when Bear Stearns started running into trouble in summer 2007 that 1-year vol rapidly repriced.” Which once again begs the question: what event will be this cycle's “Bear Stearns” catalyst.
The curve then re-inverted and by the end of the decade the recession arrived four years after the first curve inversion.