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Goldman Floats Case for Lower VIX Even in Event of Recession

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(Bloomberg) -- A recent bout of volatility in US equities has prompted some traders to think Wall Street’s so-called fear gauge should be higher. For Goldman Sachs Group Inc., that isn’t necessarily the case.

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In fact, strategists led by Rocky Fishman recommend investors buy puts on the Cboe Volatility Index, effectively betting on relative calm in coming months. The VIX, a gauge of cost for S&P 500 options, historically tends to move in the opposite direction of the equity gauge 80% of the time. At one level, the team’s prediction for lower VIX implies a call for higher share prices.

Fishman’s reasoning is primarily based on historic patterns, but if the call turns out to be true, it may not sit well with money managers who have spent all year selling stocks to raise cash. Already, the market bounce this month has forced short sellers to cover their bearish positions furiously to limit losses.

The way Fishman sees it, there will be “plenty of room” for actual volatility to drop even if the US economy suffers a recession, because at 29%, the current reading already exceeds the peak level seen around 11 of the last 13 economic downturns. Given that realized and implied price swings have shown a predictable relationship, more tranquility in the market is likely to lead to a lower VIX.

“There is plenty of precedent for realized vol well below 30 and even below 20 in strong S&P 500 selloffs and even in recessions, so a low-20’s VIX would not be unusual,” the strategists wrote, adding it’s time to buy VIX puts in part because option prices have come down “substantially.”

The VIX dropped for a third day to trade near 23 on Thursday, heading toward a three-month low. Down almost 1 point over four days, the index is poised for its fifth weekly decline -- the longest streak since July 2020.

The gauge has failed to spike higher since peaking in March even while stock prices kept hitting fresh lows. That has raised doubts over its role as the fear barometer. Its subdued movement relative to other assets, particularly Treasuries, prompted strategists at Bank of America Corp. to warn that equities are underpricing the recession risk.

Read more: Rates Volatility Lapping the VIX Is Latest Cross-Asset Conundrum

To Goldman strategists, the elevation in Treasury volatility will offer support for the VIX.

“Ongoing high rates volatility, driven in part by poor liquidity, should keep a floor on equity volatility, though, especially given how closely equity prices have been associated with cost of capital changes this year,” they wrote.

Stocks ticked higher Thursday as investors assessed the latest earnings reports and prospects for growth as the European Central Bank joined global peers in tightening policy and data pointed to a weakness in the US economy.

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