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Cantor Fitzgerald strategist Pete Cecchini, who we noted last week made a good call on the simultaneous faceplant by silver and stocks, has a new note out today suggesting you might want to buy some volatility protection. The reason: The end of QE2.
As 2008 made plain, liquidity and volatility are inversely correlated. As liquidity disappeared, even spreads in the Treasury market widened; the VIX spiked above 80; and spreads in the secondary market for secured bank debt traded wider than unsecured high yield credit. Analogously, the injection of massive amounts of liquidity over a short period of time has led to lower volatility in equities, credit and commodities markets (until last week). We believe the markets are in the process of discovering that the Fed's accommodative policy has created “transient” positives and that the cost of capital will rise as the Fed fails to wet investors' whistles in the way they have become accustomed.
He notes that, since the Fed’s April 27 press conference promising there would be no QE3, the VIX has edged higher, while stock and commodity prices and Treasury yields have fallen.
Expect more of that with the end of QE2, Cecchini says:
Because of the inverse relationship between liquidity and volatility, we believe that any withdrawal of liquidity necessitates a higher volatility environment. From that we might conclude that volatility as an asset class presents an interesting way to hedge the kind of withdrawal of liquidity we are suggesting.
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