Volatility Hits 24-Year Low: Calm Before the Storm?
Wall Street hasn’t been this confident since 1993 – at least, if you’re a proponent of the CBOE VIX Volatility Index.
The VIX is a barometer of investor fear that measures implied volatility in S&P 500 Index options over the next 30 days. It is designed to move inversely with the S&P 500 the majority of the time. When the VIX falls, it usually means stocks are rising. When the VIX rises, stocks are usually on the decline.
The so-called “fear index” closed at 9.36 on Friday, on a scale of 1-100 where 20 represents the historic mean. By comparison, U.S. stocks closed near record highs. The inverse correlation is easy to spot:
A Bull Market With Legs
Volatility has been in a perpetual state of decline since the aftermath of the Brexit vote, when markets quickly recovered from their biggest sell-off in history. The VIX declined more rapidly following the election of Donald Trump, as investors rallied behind the incoming administration’s pro-growth policies.
In addition to Trump’s pro-growth policies, markets have benefited from a resurgence in corporate profits after a so-called “earnings recession” on Wall Street. Tepid economic growth on the domestic front has shored up confidence that the Federal Reserve is in no rush to normalize monetary policy over the medium term.
But the VIX has been far more sporadic in recent months. As the chart above demonstrates, volatility has been “in play” several times this year, as markets gyrated in response to political chaos in Washington and, more recently, a rotation out of technology stocks.
Not Everyone Is Convinced
At the same time, America’s second-longest bull market has many detractors, even among the mainstream investment community. For starters, fund managers are becoming more hesitant to buy equities, with a net 80% of investors signaling that the U.S. is the most overvalued region, according to Bank of America Merrill Lynch. In fact, fund managers haven’t been this underweight U.S. stocks since before the financial crisis.
On Capitol Hill, the failure to repeal and replace Obamacare has hurt President Trump’s political capital, possibly setting the stage for further clashes on tax reform and deregulation. Political chaos was the main source of volatility on Wall Street through the first six months of the year, as evidenced by the market’s reaction to the ongoing probe over Russian interference in the November election.
Remember: the VIX is a mean-reverting indicator, which means it usually finds a way to return to its “sweet spot.” At its current level, the path of least resistance may be up.