Via ConvergEx's Nick Colas,
Who’s afraid of the big bad bear? No one, it seems.
The CBOE VIX Index sits at 13, just 8% higher than its one year low from last July. In our monthly look at the “VIX of” everything from tech stocks to gold and high yield bonds, we can see why. It is the most interest rate-sensitive industry groups – Utilities, Consumer Staples and Telecomm – that show similar levels of implied volatility in their listed options (what the VIX actually measures). At the other end of the spectrum are Energy, Financials and Consumer Discretionary names. These groups are still 25-98% away from their one year lows in terms of their “VIX”.
Given that declining implied volatility correlates with rising asset prices, this makes these the go-to groups for traders looking for “catch up” moves if volatility continues to decline. A big “If” indeed, because it’s clear from this analysis that equity market prices are anchored by one central assumption: that the Fed will raise rates once this year, at most.
Back in 2007 a Chicago man named John Maloof bought a box at a storage locker auction, just like you see people do on those reality TV shows. He was looking for historical pictures of his neighborhood for a book project. After scanning through the boxes he had purchased he was disappointed to find that nothing really fit the bill. He put the box away and moved on.
Two years later, he opened the box again and started looking through the images. What he found were thousands of street photos. People, kids, animals, everyday life. He put some of the images up on Flickr, and got rave reviews. After some detective work, he found out that the photographer’s name was Vivien Maier and she had died in 2009. No one had ever heard of her, but the quality of her work and its breadth – well over 100,000 images once Maloof tracked them all down – was astounding.
Despite her obvious talent, Vivien Maier was not a professional photographer; she was a nanny. Once Maloof tracked down the families that had employed her over the years, her story became clearer. She would take the children in her charge for long walks, snapping pictures all the way. Here are a few links of her work: Street scenes, black and white:, Some color photography, and a trailer to a movie about her life and art (about 2 ½ minutes long).
Vivien Maier had something that many investors would appreciate: the ability to see life just a little bit differently from the rest of us. Not so much so that it becomes frightening or morbid, but rather just enough to reveal something deeper. Very few people have the talent to pull that off, but it can be an object lesson nonetheless.
Back in the more prosaic world of capital markets, one way we look for a slightly different perspective on stock and bond prices is to examine the listed options market for a whole range of asset types and industry groups. The idea here is to isolate the “Implied Volatility” in these options prices, very much like the CBOE VIX Index measures the uncertainty implied by S&P 500 futures market. Over time, the VIX has been conflated with “Fear” – a larger VIX implies more near term worry about a decline in large cap U.S. stocks, and a lower VIX points to less concern.
The above charts show the findings of our monthly analysis, but here is a summary of what we see in the data:
The decline in the CBOE VIX to its current 13 reading, not far off the closing one-year lows of 12, is mirrored by the general decline in implied volatility across the 19 industry groups and asset types we track. The “VIX of” high yield bonds, for example, was down 17.5% last month. All three market cap ranges for U.S. stocks – small, mid and large – saw declines in their “VIX” as well. The only asset classes that saw meaningful increases in their “Fear Indices” were silver (+11%), EAFE stocks (+7%) and Investment Grade Bonds (+3%).
Why the complacency? The answer offered by the Implied Volatility data is clear: equity markets don’t believe the Fed is going to raise rates more than (maybe) once this year. Looking at the one year trends in Implied Vol (the “VIX of”) for three rate sensitive groups – Utilities, Telecomm and Consumer Staples – all three are also at/near their one-year lows for “Fear”. All three sectors are known for stable dividend payouts and (therefore) their bond-like qualities. If there is little “Fear” baked into their options, it is because investors believe the Fed is on a slow path to raise rates because inflation remains at bay.
Any groups that might still move? The rally in global equities from their February lows has become the most hated move in the most hated long term bull market in history. That said, the price action says investors and traders are starting to join the bulls since they obviously haven’t beaten them.
For those looking for laggard groups that might still move as markets rally further, three pop out of our analysis today: Energy, Financials, and Consumer Discretionary. Energy, for example, is still not close to its 2015 lows for Implied Volatility. Current readings for the “VIX of” Energy stocks are 24; the lows were 12. Same for Financials, where the lows were 12 and current readings are 16. Consumer Discretionary “VIX” sits at 13 and the lows last year were 11.
Since price and Implied Volatility are typically inversely correlated, a further decline in the “VIX of” these groups should coincide with higher price levels.
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There is an elephant in the room, of course, so we’ll finish up by taking its picture, Vivien Maier style.
When the VIX goes below 14, it is one standard deviation away from its long run average of 20. Not enough to signal an imminent correction, but enough to cause concern. As we outlined, market action is sending a very clear message:
The Fed is on hold or may raise rates once this year.
Currency volatility, thanks to an unofficial truce at the Shanghai G-20 meeting, is low and will remain so.
Negative interest rates in Japan and Europe will keep US long term rates low as well, supporting equity valuations.
The U.S is not going into a recession (and neither is any other major developed economy), even though current GDP growth is close to zero.
Now, if you agree with this set of assumptions, then stocks still have room to run.
But if you have any concerns, well, it might be better to wait for that “Modest pullback” everyone keeps looking for.
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