All Quiet on the Western Front


by Timothy D. Carkin
Senior Vice President

All Quiet on the Western Front

In a week full of geopolitical news, the market showed a bit of malaise. The S&P 500 posted a small loss of 0.4 percent. Bonds were similarly docile with the 10-year U.S. Treasury ending the week off two basis points at 2.3 percent. This comes after equity markets have rallied more than 2.5 percent since their April lows set just before the “Frexit” vote. But now that more than 90 percent of companies have reported earnings the market has slowed to digest the earnings news. A bright point in that news is earnings growth is on pace to mark the highest year-over-year rate since the third quarter of 2011.

Market Volatility, or Lack Thereof…

The VIX Index, the so-called fear gauge for U.S. stocks, fell earlier this week to its lowest close since 1993 and other volatility measures show the markets at this level of volatility less than 3 percent of the time since 1928. The last 14 trading days have seen the S&P 500 in a tight trading range between 2,380 and the elusive 2,400. Is this the calm before the storm or a sign on continued good times? Analysts across “the street” are divided on what this means.

The VIX index measures implied volatility and is used as a barometer of investor fear. The metric is derived from the prices of put and call options on the S&P 500 which illustrate the amount of risk that investors expect to experience. Normally, bullish periods in the market see a reduction in volatility as investors become comfortable with a rally. Conversely, a bearish turn to the market is usually accompanied by an increase in volatility, as investors try to hedge their holdings. Another way to look at the low VIX levels is as a form of insurance. Right now, insurance on your portfolio is cheap because investors think a drawdown in stocks is low. This is by no means a reading of actual investor risk, rather it registers perceived risk.

Since the 2008 financial crisis, the massive amount of monetary stimulus has implied volatility registering abnormally low readings more often than not. This reduced volatility is showing up in stocks, bonds and currencies. There are plenty of good reasons for this low volatility: equity markets are setting new highs, interest rates are still low relative to historical averages, Congress and the President are discussing tax cuts and business-friendly legislation and our economy and inflation are both in check. It is quite possible this low volatility period that illustrates investors’ confidence in the economy and faith that the rally is not over.

The constant undertone when speaking about low volatility is the other side of the coin: investor complacency. Volatility can’t stay at these levels and something must shock the market back to normal levels. Right now, you see dips in the market caused by events such as “Brexit” and “Frexit” followed by a rally. What worries some analysts are the myriad things that could break the markets’ tight range. Past periods of ultra-low volatility like 1993-94 and 2006-07 were followed by dislocations in the market. A lower VIX level does not necessarily foreshadow another financial crisis, but it can be an indicator of a market vulnerable of a shock.

As stated earlier, analysts across the spectrum are contemplating what the low levels in the VIX mean. Currently, we are neutrally positioned in the markets but are closely monitoring the VIX and other measures and their movements.

Takeaways for the Week:

  • Despite a lot of geopolitical activity, markets were rather subdued this week
  • Market volatility is very low at the moment, but we continue to gauge what that may mean