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A 'bubble' no one is talking about

Myles Udland
·3-min read

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Thursday, February 25, 2021

The VIX, according to JPMorgan

Because an infinite loop timeline currently runs financial markets news these days, shares of GameStop (GME) doubled in the final hour of trading on Wednesday.

This kind of action serves as an unsettling sign to many investors: after all, the random doubling of stocks that have already seen precipitous rises and falls doesn't exactly suggest everything is fine.

And thus we find that there is one word on the tip of everyone's tongue these days — bubble.

Of course, any time stocks go up at all it seems that many are quick to either declare or at least warn of potential bubbles.

The entire concept of a "bubble" has really just become a catch-all for pointing to something someone doesn't like or a perceived mispricing in the market, no matter how modest that mispricing may be.

And so it is with this second frame in mind that JPMorgan quant and derivatives strategist Marko Kolanovic writes on Wednesday that, "If we want to be thorough in our search for bubbles, there is another asset that is currently in a bubble – the VIX."

"The VIX is now disconnected to underlying short term S&P 500 realized volatility," Kolanovic adds, "indicating a bubble of fear and demand from investors looking to hedge or profit from a hypothetical market selloff."

On Wednesday, stocks rallied after a couple choppy sessions to start the week as the Dow closed at a record high. The VIX was also under heavy pressure on Wednesday, settling at 21.44 and down almost 2 points on the day.

"Given the VIX is at a near-record premium to actual equity volatility (~400-500% above the 'fair value') we think selling the 'VIX bubble' represents a good market opportunity," Kolanovic writes.

Moreover, Kolanovic thinks investors are mistaking enthusiasm in some parts of the market for enthusiasm in all parts of the market.

"While there is a lot of talk about bubbles, it is hard to see one in the broad equity market, where a dominant group (FANGs) practically hasn’t moved for 6 months despite massive amount of stimulus and an expected economic recovery, Financials that have barely recovered 2020 losses, and Energy that is still down 25% from last year despite a commodity bull market," Kolanovic writes.

Adding: "We do see some relatively contained market segments that appear to be in a bubble related to Electric Vehicles (EV), renewable energy and innovations stocks. These sectors only make up a small part of the market (e.g., electric vehicles make up only 2% of the S&P 500), but we do see segments that remain cheap such as energy where positioning remains heavily underweight. We believe that this is only the first inning of the market rally, and that the rotation into cyclicals could play out for the next year."

And so while it's tough to declare a game over when we're only in the first inning, the GameStop situation does suggest this contest could be a whole lot of fun.

And who doesn't love fun?

By Myles Udland, a reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

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