Volatility is too low, traders should sell bounces

• Due to several measures, the stock market is the quietest since the end of 2021.
• JPMorgan quantity guru Marko Kolanovic says the stock market is far too calm right now given all the headwinds it’s facing.
• He says technical factors are dampening volatility in the face of rising interest rates, credit tightening and macro risks.

The stock market is currently very quiet. Maybe too quiet.

Price swings are dampened no matter how you look at them. On a 30-day forward basis slightly measured by the VIX, commonly referred to as the stock market fear gauge, traders expect the lowest volatility in more than two years. On an actual realized basis, the past 30 days have also been the quietest since 2021.

That calm is in stark contrast to all the headwind that is currently blowing. A major factor is rising interest rates, which have been consistently raised by the Federal Reserve for more than a year in an effort to cool inflation. Yes, inflation has come down, but the central bank has yet to signal that it is ready to hit the brakes.

Those rising rates have led to a tightening of credit availability, a dynamic that was amplified by the recent turmoil in the banking system. There is also the ever-looming geopolitical overhang of the Russia-Ukraine conflict, and the widespread impact it has had on energy and currency markets.

The chart below shows how range-bound markets have been so far in 2023, compared to the second half of 2022. While multiple asset classes closely match their previous ranges, none do so more than equities.

Marko Kolanovic, JPMorgan’s chief market strategist and co-head of global research, agrees with all who say that the forces outlined above should turbulent markets. That they aren’t, he says, comes down to temporary technical factors. Be careful once these are removed.

Kolanovic is referring specifically to the dominance of option sellers, whose activity he says leads to intraday stock price reversals, which naturally leads to flat trading for the overall market. That moderate volatility then prompts mechanical buyers such as volatility-focused and risk parity funds to add exposure. The net result is a market that oddly seems to be unaffected by negative headwinds. (For context, the VIX generally trades inversely relative to the S&P 500, so gains in stocks are usually associated with a low VIX reading.)

“These market dynamics artificially suppress perceptions of macro-fundamental risk,” Kolanovic wrote in a new client note Monday.

The key word there is “artificial,” which reflects the unsustainable nature of the current calm in the market.

Kolanovic took his comment a step further and recommended further rallies in stocks: as soon as you see a bounce, hit the sell button and grab some profit.

“Robust fundamentals bode well for Q1 earnings results, but we recommend using any market strength in reporting to reduce exposure,” he concluded.