The implosion of a wildly popular trade was actually a good thing for markets, Morgan Stanley's US equity chief says

Wikimedia Commons

• Morgan Stanley chief US equity strategist Mike Wilson says the implosion of the immensely popular short-volatility trade was actually a positive for markets in the long run.
• Overall, Wilson has been impressed by the equity market's resilience since the correction that rocked investors earlier this month.

The recent stock market correction featured a reckoning of sorts for one of the hottest and most profitable trades around: shorting volatility.

When the Cboe Volatility Index (VIX) more than doubled in a single day, short positions on the so-called fear gauge were wiped out as the spike forced investors to cover. Left smoldering in the wreckage were two exchange-traded products (ETPs) linked to the VIX, which lost 95% of their market value on a combined basis.

Yet while the blow-up may seem troublesome on the surface, Morgan Stanley chief US equity strategist Mike Wilson argues it was actually a positive for the long-term health of the market.

He thinks the VIX ETPs were a latent risk for the market, and we're better off now that their influence has been dampened. Now they'll be unable to exacerbate broader market moves like they did during the equity selloff.

It's a sentiment shared by many across Wall Street who warned for months short-volatility strategies were a ticking time bomb of sorts.

In an interview with Business Insider, Wilson elaborated on those thoughts and also expressed his views on the market cycle, his 2018 forecast, and the outlook for stock pickers. Read the full interview here.

Here's what Wilson had to say (emphasis ours):

"We cleansed a risk that was out there for the marketplace. And it wasn't just those products. It also included risk-parity strategies and volatility-targeting funds. Obviously if volatility picks up in the broader market, they have to reduce their risk.

I'm somewhat encouraged actually that as volatility spiked so much, the selloff was relatively contained to around 10%, and only lasted for 4-5 days. I think the markets handled it extremely well. That's encouraging. It tells me that the integrity of the market is actually better than some had been fearing, given fears over passive investment and crowding.

If we ever do have a real fundamental selloff or recession, people are worried that there's going to be unlimited selling from these strategies, but I think that's wrong. The market handled this risk very efficiently."