As summer settles over a sideways stock market, traders are complaining that the tape is too sluggish, even as many investors are bemoaning all the turbulence.
Both groups of whiners have a point - which is the mark of a frustrating, hard-to-read (and harder-to-ride) market.
All the data conjured by statisticians to measure current and expected market volatility have sagged to multi-year lows. The CBOE S&P 500 Volatility Index (^VIX) – the once obscure but now ubiquitous VIX – is below 12, at a 14-month low and in sight of its all-time rock bottom just below 10. Two years ago, it was above 25.
The cereal-box wisdom on the VIX is that when it’s low, it means investors are complacent and stocks are toppy, while a high VIX shows extreme fear that will dissipate through rising share prices.
As I discuss with Jeff Macke in the attached video, though, the VIX merely tracks the prices of stock-index options, which encompass the market’s best guess on the volatility of the S&P 500 over the next 30 days. And that best guess is informed most directly by exactly how volatile the index has been in recent weeks or months.
And right now, the market has been going nowhere – slowly. The S&P 500 has been stuck between 1860 and 1900 for five weeks, a vanishingly tight range. In the past three months, it has been contained in a 5% range from low to high. Measured, actual volatility over the past 10 days has been a 9, in VIX terms. In other words, the VIX isn’t “low” in terms of its most important input – VIX in fact is already pricing in some pickup in the market’s metabolism, even as it sits near 11.5.
Yet despite this measurable torpor, the past few months have felt uneasy to lots of investors, and, as Macke notes, the S&P 500's levitation act near all-time highs has drawn out many would-be prophets of a coming crash.
The market’s felt treacherous to many because there has been lots of day-to-day choppiness, and individual pockets of the market – such as small-cap stocks, biotech names or Internet growth darlings – sold off heavily as boring, old blue chips hold up the index.
When different groups of stocks take divergent paths, it has the effect of offsetting currents, stalling the index and suppressing volatility. The action has been pretty consistent with the idea I offered recently that we are digesting last year’s broad, straight-up ramp in stock prices, and might be in for a fair bit of churn this year, just as we saw in a similarly situated year, 2005.
Importantly, though, the current doldrums are not strictly a stock-market phenomenon.
As a smart new Economist magazine piece on the “volatility crash” details, extreme calm has also overcome the bond and currency markets, with Treasury yields drip-dripping toward 2.50% and price swings in foreign exchange likewise at multi-year lows. But why?
The world is awash in cheap liquidity and, for the moment, many of the dominant macro threats of the past few years appear to be tamed. Easy money has smothered financial-market volatility. There is broad agreement on the likely course of central-bank policies on three continents, including the Federal Reserve’s methodical and thoroughly well telegraphed “tapering” of its bond-buying program. Europe has not disintegrated, China hasn't landed hard, and growth is positive worldwide but slow enough to reduce concern about any sudden spurts in inflation.
All of this, generally, is a good thing to the extent that it means the world economy and asset markets have returned to health from the financial crisis and its aftershocks.
But there’s a risk that this engenders an excess of investor “certainty” - overconfidence in the stability of the system and a willingness to pile on a lot more risk in pursuit of better returns.
There is a widely observed tendency now to chase after scarce yield, accepting meager compensation for, say, owning debt of low-rated companies or the Greek government. With leverage added on top of under-priced risks, and untested structures such as junk-bond exchange-traded funds a major presence, trouble can ensue when volatility inevitably lifts.
There is no science to determining when such an upward reversion of market volatility might occur, though. Stock volatility got lower in the middle of the past decade, and stayed there a long while. And it’s comforting that the financial core of the system – the big banks – has a much fatter capital cushion than before the last crisis.
The next reawakening of volatility need not be as jarring as what we saw in 2008, or even in the sudden gut check of 1998. But eventually, the market will again enter interesting times, and many traders will wonder why they wished for an end to the calm.
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