(Wall Street strategists and hedges funds alike are sounding the alarm on unstable conditions brewing under the surface of the US stock market.Wikimedia Commons)
To a growing chorus of strategists and investors across Wall Street, the stock market looks like it's headed for a rude awakening.
Their mounting pessimism comes at a time when US equities are looking healthy, at least on the surface. Major indexes are hovering near record highs they reached this past week, while corporate earnings are growing at a blistering pace.
Yet some market experts think this apparent strength is just masking deeper problems brewing under the surface.
Count Marko Kolanovic, JPMorgan's global head of quantitative and derivatives strategy, as one of those stressing caution. In a client note on Thursday, he said that record-low volatility should "give pause to equity managers." Kolanovic even went as far as to compare the strategies that are suppressing price swings to the conditions leading up to the 1987 stock market crash.
"The fact that we had many volatility cycles since 1983, and are now at all-time lows in volatility, indicates that we may be very close to the turning point," he said.
A sudden move down in US stocks on Thursday — including a notably outsized loss in tech — was widely attributed to Kolanovic's note, highlighting just how seriously many investors have started taking such warnings.
(The VIX — or stock market fear gauge — hit a record intraday low last week.Markets Insider)
His consternation extends into the hedge fund world, where investment managers are also crying foul about low volatility to anyone that will listen.
Baupost Group, a $30 billion fund, recently highlighted the lack of price swings as a harbinger of pain to come, calling it a possible "accelerant for the next financial crisis." Meanwhile, Highfields Capital Management, which oversees $13 billion, said this past week that low volatility is giving people the false impression that the market is risk-free.
Going beyond the much-maligned low-volatility environment, Bank of America Merrill Lynch has its own reasons for expecting an upcoming rough patch in stocks — one it sees coming sometime this autumn.
Michael Hartnett, the chief investment strategist of BAML Global Research, points to how the S&P 500 has continued climbing to new highs, even as the size of the Federal Reserve's balance sheet has stayed relatively unchanged. He says this divergence is a "classic euphoria signal." Such overexuberance has historically been a sign that investment sentiment is overextended.