Eq: Total Market
A perplexing situation is the sanguine state of volatility despite a torrent of risks and negative headlines such as deep stress in the banking system due to an inverted yield curve, rising recession risk, inflation, a hawkish Fed, geopolitical concerns, and a looming debt ceiling deadline.
In Barron’s, Lauren Foster covered some recent comments from Vanguard on the debt ceiling and its impact on volatility. According to the asset manager, more volatility is likely but there’s little to worry about in terms of a default on the debt as it believes an agreement will be reached. However, it sees volatility rising into the deadline.
It also believes that the deadline could be shifted later or that a temporary agreement could be reached. Even if a technical default happens, it’s unlikely that the US would not meet its obligations but it could affect the timing of a payment. But, the asset manager doesn’t think that investors should worry about this scenario. Instead, they should focus on good risk management practices and sticking to their long-term investment plan.
Finsum: Volatility has remained subdued despite the market facing considerable risks. Vanguard shares its perspective on the matter and how a debt ceiling breach would play out.
There are considerable headwinds facing the stock market and economy such as a hawkish Fed, uncomfortably high inflation, debt ceiling deadline, an upcoming election year, increasing risk of a recession, a potential regional banking crisis, and geopolitical tensions.
Yet, the volatility index has trended lower for much of the year and is now at its lowest levels in over a year. Ron Isbitts covered this matter and why it could be an opportunity for ETF investors in an article for ETF.com.
If investors believe that volatility is mispriced, then there are some different volatility ETFs to consider. The ProShares VIX Short-Term Futures ETF offers exposure to volatility over the next 1-2 months. The ProShares VIX Mid-Term Futures ETF holds volatility contracts with a duration of 3 to 6 months.
There are also ETFs for those with a variant view. The ProShares Short VIX Short-Term Futures ETF moves inversely to volatility, allowing holders to profit from falling volatility. For those who want to generate income from volatility, the Simplify Volatility Premium ETF also tracks volatility but also produces a dividend for holders.
Note that these ETFs tend to have slippage, high costs, and underperform the S&P 500 over the long-term. Thus, they are best used tactically and with discretion.
Finsum: Volatility is declining despite several potent risks for the market. There are several options for investors to consider.
Someone say doomsday scenario?
Or at least strongly imply it?
Democrat; Republican -- you can just shunt the ideologies aside. Both have a separate point of view with no end in sight in order to circumvent default as the government edges toward its so-called debt ceiling x-date, according to cnn.com. That, of course, is when the Treasury could find its pockets empty, meaning paying all government obligations would require extraordinary measures.
Okay, so while the odds still are relatively low that the government will default on its debt, Wall Street’s no fan of the impact the equity markets would feel in light of debates flashing no indications that the credits are anywhere near rolling.
Meantime, investors should devote rapt attention over the next few weeks and, as one expert suggests, stand poised to become “a bit more defensive,” according to cnbc.com.
At this point, at least, setting aside the fact the short term Treasurys have priced in reluctance, significant volatility isn’t necessarily in the cards as far as the markets are concerned.
“Congress was willing to play the game of chicken, but there were fewer members of Congress actually willing to crash the car,” said Betsey Stevenson, professor of public policy and economics at the University of Michigan.
In an article for MarketWatch, Jamie Chisholm discussed some reasons for why stock market volatility has remained depressed despite the ongoing crisis in regional banks which some fear could lead to a credit crunch. In contrast, the stock market seems more responsive to economic data and the Federal Reserve.
Economic data continues to signal an economy that is growing albeit decelerating but also not in a recession which would hurt corporate earnings. Q1 earnings also have come in stronger than expected.
The Federal Reserve is in the final innings of its rate hike cycle. Futures markets are already looking ahead at rate cuts by the end of the year or Q1 of next year. And, inflation data continues to moderate and move in the right direction which is also supportive of asset prices.
It’s also surprising that the market seems unconcerned about the debt ceiling deadline and a potential default, although there has been chatter about positive progress from negotiations between Republicans and Democrats. Surprisingly, the regional bank crisis is having little spillover impacts on the market or economy. In fact, the S&P 500 is 3% higher than from when the crisis began, while the Vix is nearly 10% lower.
Finsum: One mystery for market participants is that volatility remains depressed despite ongoing struggles for regional banks and a looming debt ceiling deadline.
In an article for Reuters, Mike Dolan discussed the widening gap between market volatility which has been trending lower since October of last year and headlines of various geopolitical, financial, and economic risks that are increasingly dominating headlines. The Federal Reserve is expected to hike rates despite signs that the economy continues to decelerate, considerable stress in the banking system, increasing chatter of a ‘technical default’ for the US Treasury if the debt ceiling is breached, and important data points in the coming weeks in the form of earnings from tech giants and the April jobs report.
Despite these potential threats, the VIX, which measures stock market volatility, reached its lowest levels since November 2021. The stock market is also nearing a 20% move rise from its October lows, which many market participants would define as a new bull market. Volatility is similarly depressed in the Treasury market and the currency markets despite upcoming central bank meetings, indicating that this divergence between the VIX and headline risk is not unique to equities.
Finsum: There is a widening gap between various headline risk and market measures of volatility which are at multi month lows.
In an analyst note, JPMorgan’s Chief Equity Strategist Marko Kolovanic discussed the anomaly between an increasingly shaky market and economic outlook, in contrast to the S&P 500 volatility index (VIX) which continues to trend lower.
A week ago, the VIX dropped to 16 which is its lowest level since November 2021, despite the S&P 500 being 16% lower compared to 17 months ago. Yet, economic growth continues to decelerate, inflation is meaningfully higher, and the Fed remains in a hawkish posture.
Kolovanic notes that we are not likely to see any abatement of these pressures in the coming months given the tightening of financial conditions and rising recession risk, while the Fed’s priority remains stamping out inflation even at the expense of the economy and labor market. Further, he notes stress in the banking system and drumbeat of rising tensions regarding China, Russia, and an upcoming election cycle.
He says depressed volatility is due to technical reasons, primarily the selling of short-term options which leads to dealer buying of stocks and volatility leaking lower. Adding to this is continued resilience in Q1 earnings while many were anticipating a meaningful decline.
Finsum: Volatility is at 17 month lows despite stocks being much lower. JPMorgan’s Marko Kolovanic explains some reasons behind this discrepancy.