Days of Market Calm Seen Ending in Hedge Fund VIX Bets

Hedge funds are saying goodbye to the calm that blanketed U.S. stocks for the past two years.

Large speculators have reduced bets on lower volatility and were net short about 1,000 contracts on VIX futures last month, the fewest since 2011, according to a report from the Commodity Futures Trading Commission. The action amounts to speculation equities will keep falling since the Chicago Board Options Exchange Volatility Index moves in the opposite direction of the Standard & Poor’s 500 Index about 80 percent of the time.

Steady gains that pushed U.S. shares to the biggest annual advance in 16 years are disappearing amid a rout in technology companies, concern about earnings and the prospect of less economic stimulus. Losses from the past two weeks have pushed the VIX to the highest level since December 2012 versus a volatility measure combining stocks, interest rates, currencies and commodities, data compiled by Bloomberg show.

“You may be seeing the first indications that the days of very low volatility are numbered,” Arthur van Slooten, a strategist at Societe Generale SA, said in a phone interview from Paris on April 11. “Expectations for rate hikes may become more aggressive when the data from the U.S. starts heating up.”

While bearish contracts on the VIX have increased in the past two weeks, the level is about half the average from 2012 and 2013. They are net short 31,746 futures on the gauge, compared with a mean 61,953 in the last two years, data from a Commitment of Traders report by the Washington-based CFTC show.

VIX Shorts

U.S. stocks had one of their most tranquil years in 2013 as investors became more confident in the bull market and began returning cash to mutual funds. The VIX averaged 14.3 last year, the lowest level since 2006. It has fallen more than 18 percent annually in four of the past five years.

The persistent decline lured hedge funds to short the volatility gauge, which is based on the cost of options on the S&P 500. Large speculators had a record 116,000 net-short positions on VIX futures in August, CFTC data show.

They’ve all but disappeared as equities suffered the biggest weekly decline in almost two years. Investors are questioning stock valuations as the Federal Reserve reduces stimulus during a strengthening economy.

Fed Chair Janet Yellen said in March that interest rates may rise around six months after the central bank ends its bond buying. Improvement in the labor market helped push consumer confidence in April to the highest level since July, the Thomson Reuters/University of Michigan preliminary index of sentiment showed last week.

Market Rally

“The market cycle is quite mature following five years of a stock-market rally,” Tristan Abet, a strategist at Louis Capital Markets LP in Paris, said by phone on April 11. “We are probably closer to the end than to the start of a cycle. When the cycle is maturing, volatility tends to increase.”

The VIX jumped 22 percent last week to 17.03 amid disappointing earnings results from JPMorgan Chase & Co. and signs hedge funds are selling their top performers. Bank of America Corp.’s Market Risk Index reached negative 1.04, a one-year low. The S&P 500 lost 2.7 percent, the most since June 2012.

The VIX slid 5.4 percent to 16.11 at 4 p.m. in New York. Europe’s VStoxx Index gained 1.1 percent to 18.50, the highest level since March 24.

For Jacques Porta at Ofi Gestion Privee in Paris, the selloff is a chance to buy stocks at a discount. More than 75 companies in the S&P 500 have suffered losses exceeding 10 percent this year, data compiled by Bloomberg show. The Nasdaq Biotechnology Index fell for the last seven weeks, the longest losing streak since 1998, as the gauge entered a bear market.

Unjustified Losses

“There’s a good opportunity to begin to buy,” Porta, who helps oversee $780 million at Ofi Gestion in Paris, said on April 11. “We see a lot of declines in some stocks, which seem to me are unjustified.”

Futures show traders expect the VIX to stay near current levels. May and June futures ended last week around 16.7, below the spot level, data compiled by Bloomberg show.

Pressure may be mounting on professional speculators with losses in individual stocks spurring more pain than they do for ordinary investors. The average hedge fund has 63 percent of its assets invested in its 10 largest holdings, twice as much as mutual funds, according to a Goldman Sachs Group Inc. note from Feb. 20. About 28 percent of their holdings changed in the fourth quarter, an all-time low, the note said.

Falling Bets

The percentage of hedge-fund holdings that amount to bets that stocks will rise has decreased to 46 percent from 58 percent earlier in the year, a sign of selling, according to an April 9 research note from Credit Suisse Group AG. Net exposure in the U.S. declined to the lowest level since August 2012, the report said.

Concern about further declines boosted trading in options that increase with more volatility. More than 760,000 VIX calls changed hands on April 11, 77 percent more than the 10-day average, data compiled by Bloomberg show.

“The VIX is telling you people are getting nervous,” Greg Eckel, a fund manager at Morgan Meighen & Associates Ltd., said in an April 10 interview from Toronto. His firm manages about $1.3 billion. “The sentiment has turned. It’s clearly taken a negative tone unfortunately and we’ll have to ride through that with hopefully not a lot of damage.”

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