A little over two weeks ago, the head of JPMorgan Chase's (NYSE: JPM) investment bank issued a rare warning about the state of the stock market, telling research analysts at Keefe, Bruyette, and Woods that the bank is anticipating a "painful market correction in the near future,"Â according to Business Insider.
And Daniel Pinto isn't just saying this -- JPMorgan Chase also is backing it up with action by "beefing up risk management and hewing conservative."
Image source: Getty Images.
Pinto is concerned about complacency in the markets. You can get a sense for this by looking at the S&P Volatility Index (VOLATILITYINDICES: ^VIX), otherwise known as the VIX, an index that tracks expected stock market volatility over the next 30 days, with a higher number implying higher expected volatility.
The average daily close of the VIX since 1990 is 19.4, according to Yahoo! Finance. But this year, the average is only 11.2 -- just about half its historical average. The implication is that, when the market does correct, which is inevitable, investors and traders will be caught off guard, increasing the chance that they'll aggravate the correction by selling in a last-minute rush.
There's nothing wrong with expected volatility being low, but it doesn't seem to match up with reality right now, given the political environment in the United States, as well as the deteriorating geopolitical situation in the Middle East and Europe.
Ray Dalio, the founder and former CEO of Bridgewater Associates, the world's largest hedge fund, made this point earlier in the year:
Ordinarily, politics and economics influence each other with economics being more of a driver on politics than politics is on economics -- e.g., bad economic conditions normally lead to political changes -- and normally we don't need to pay much attention to politics to get the economics and markets right. However, there are times when politics becomes the most important driver. History has shown us that these times are when there is great economic, social, and political polarity within a country and there is the selection of populist leaders to fight for "the common man" in a battle against "the elites." These conditions exist now. The 1930s were the last time this happened in the developed world and globally.
A growing chorus of other distinguished financiers have joined Dalio to issue similar warnings.
No one can predict the future, not even the top executives at JPMorgan Chase, but investors would be remiss to ignore its warnings. As the biggest bank in the United States, it has access to a vast quantity of up-to-date and proprietary data, from asset prices to money flows to loan demand.
It also has a good track record at reading the tea leaves. Well before the financial crisis of 2008 materialized, JPMorgan Chase was warning about it. And the bank's CEO, Jamie Dimon, has consistently made prudent stock market purchases when shares of JPMorgan Chase fell.
Jamie Dimon, the Chairman and CEO of JPMorgan Chase. Image source: JPMorgan Chase.
Additionally, stocks haven't meaningfully corrected for almost a decade, dating back to the aftermath of the financial crisis. That's an unusually long rally. And looking at important economic indicators, like unemployment and loan defaults, suggests that the economy is a lot closer to the top of the business cycle than the bottom.
Finally, it's important to appreciate that JPMorgan Chase has no interest in raising alarm bells, as a correction could easily translate into higher loan losses at the New York City-based bank. This is probably why the bank chose Pinto to deliver the message as opposed to Dimon. Had Dimon said the same thing, it's fair to think that it could have become a self-fulfilling prophecy. Consequently, the fact that it's a statement against interest, if you will, lends it credibility.
In short, while there's no telling when the next correction will strike the stock market, it seems like it would behoove investors to have a plan for what to do when that happens.
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