Are Equities Mispriced?

23 Jul

Looking at a chart of the VIX index, we have seen a floor to the index generally being around 15 for the last 5 years but with the range 15 – 18 being the sell-trigger or the spark where the index typically sees a rise. VIX is currently at 16.27. Risk pricing in US equities is once again showing a lack of caution.

Is this a trigger to sell?   

To put it another way let’s compare VIX to IG CDX (investment grade CDS index).

Unlike VIX, which is measuring implied volatilities of options, CDX is an indicator of CDS protection premium (spreads) on the bonds of many of the same US companies. I am suggesting that this, in general, compares the risk pricing for equities with that of credit.

The scatter plot below shows VIX vs. IG CDX levels since 2009. Based on this dislocation, equity implied volatility looks relatively cheap.

Summary

The market outlook is not clear and we are sure that market volatility is here to stay.

The issue being the cost of institutional debt, especially debt in the form of Gilts, Treasury Notes and Blue Chip Corporate Bond especially – are expensive

In comparison, on a relative basis, equities seem to be cheap – financial instruments seem expensive – so a suitable market exposure approach may well be to take a classical view and own defensive equities with strong cash flows mixed with some niche markets which are less vulnerable to the current market weaknesses and/or have already seen serious market corrections.

The question is what type of investor are you? Are you investing for months, or years or a fixed point in time in the future?

I would suggest that a combination of strategies is required, combining deposit-based strategies for the short-term, structured products for, the say, 2 – 6 year focus and investment portfolio for the over 5 year investment duration.

I accept and expect every personal circumstance and focus is different.

Good luck investing.

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