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VIX Lowest to CDS Since ’09 as Stock Hedges Trail Bonds

VIX Lowest to CDS Since ’09 as Stock Hedges Trail Bonds
Traders work in the Volatility Index Options pit on the floor of the Chicago Board Options Exchange in Chicago, Illinois, U.S. Photographer: Tim Boyle/Bloomberg

Risk perceptions among U.S. equity and credit investors are diverging the most since 2009 as signs of an economic slowdown spur bigger increases in prices to protect against losses in bonds than stocks.

The VIX, the benchmark gauge of U.S. equity derivatives that usually rises when shares fall, closed last week at 0.032 times the level of the Markit CDX North America High Yield Index, which increases when confidence in debt issuers deteriorates, according to data compiled by Bloomberg. That’s near the 2 1/2-year low of 0.027 times reached in March.

While the VIX is 21 percent below its one-year average after sinking 58 percent since October, the gauge of credit-default swaps is only 2.4 percent less than the mean. Worsening economic data and concern Europe’s debt crisis is intensifying may make stockholders more inclined to hedge their gains, according to Belmont Capital Group’s Stephen Solaka.

“This could signal we have seen lows in the VIX,” Solaka, who oversees about $50 million including options as co-founder of Belmont Capital in Los Angeles, wrote in a May 4 e-mail. “After the rally we have had, I would also expect investors are looking to hedge gains in indexes, which would keep volatility bid.”

The ratio between the VIX and the Markit index, which tracks swaps on junk-rated issuers in North America, narrowed last week as the Standard & Poor’s 500 Index posted a 2.4 percent drop, the biggest weekly slump since December. The gap increased from 0.029 on May 1, jumping on May 4 after U.S. employers added fewer jobs than economists forecast in a Bloomberg survey.

VIX Surges

The VIX fell 1.2 percent to 18.94 today after gaining 17 percent last week, the most since February. It reached the lowest level since June 2007 on March 26 at 14.26. The Markit gauge rose 3.1 percent to 595.27 basis points last week. The VStoxx Index, which measures the cost of Euro Stoxx 50 Index options, fell 1.6 percent to 28.92 today.

The S&P 500 has slipped 3.5 percent from its April 2 high after economic data weakened. The Citigroup U.S. Economic Surprise Index, a gauge of how much reports differ from economists’ estimates, turned negative on April 25 following six months of positive readings. The Labor Department said last week that non-farm payrolls increased by 115,000 in April, the smallest gain in six months and less than the median economist projection of 160,000.

The benchmark measure for U.S. stocks surged 13 percent in 2012 through April 2 and posted the biggest first-quarter advance since 1998. U.S. high-yield debt returned 5.2 percent during the first three months of the year, while investment-grade securities gained 2.4 percent, according to data compiled by Bank of America Corp.


“The S&P 500 has outperformed in the first part of 2012, and this has created a divergence between it and other risk assets,” Andrew Greeley, a senior managing director at Stamford, Connecticut-based Acorn Derivatives Management Corp., which manages more than $500 million in volatility assets, said in a May 4 interview. “Either other assets stabilize, driving premiums on credit lower, or the S&P 500 should correct, pushing the VIX higher.”

The euro fell today after Nicolas Sarkozy, the French president who partnered with German Chancellor Angela Merkel to promote European austerity, was defeated by Socialist Francois Hollande yesterday. At the same time, Merkel’s party had its worst result in more than half a century in the northern German state of Schleswig-Holstein.

In Greece, an exit poll showed voters flocked to anti-bailout parties, throwing doubt on whether the two main parties, New Democracy and Pasok, can form a coalition to implement spending cuts.

Too Pessimistic

Investors are too pessimistic about the outlook for equities, making it likely that sellers have already dumped shares and leaving stocks poised to rally, Northern Trust Corp.’s James McDonald said. The last time the VIX was this low in relation to high-yield CDS spreads, the S&P 500 was in the fourth month of a bull market that’s now lasted more than three years.

Equity mutual funds tracked by the Investment Company Institute recorded $16 billion of outflows with less than a week to go last month, on pace for the worst April since at least 1984. More than 34 percent of forecasters surveyed by Investors Intelligence said stocks will fall 10 percent, the highest proportion at this time of year since Bloomberg began tracking the data in 1989.

‘Already Positioned’

“Sentiment around the world now is fairly negative,” McDonald, chief investment strategist at Northern Trust in Chicago, said in a telephone interview on May 2. His firm manages $716.5 billion. “The negative sentiment is a positive for the markets because it means that people have already positioned for bad news.”

When stock volatility is low relative to high-yield spreads, investors may want to protect their holdings by buying equity market volatility using options, according to Peter Cecchini, global head of institutional equity derivatives at New York-based Cantor Fitzgerald LP.

“Credit tends to lead equities through the cycle,” Cecchini said in a May 3 telephone interview. “The failure of high-yield spreads to pull back to recent lows, while equity volatility has pulled back to recent lows, may be indicative of the fact we’re going to see more equity volatility.”

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