Is there a paradox of low market volatility?

The FT reports:

Wall Street’s “fear gauge” has fallen to a seven-year low, helping propel US stocks to a record peak but suggesting investor complacency reigns over financial markets.

The CBOE Vix equity volatility index, a barometer of investor sentiment, slipped below 11 on Friday, nearly half the long-term average and its lowest level since February 2007. The Vix has fallen in recent years in conjunction with a robust recovery in equity prices from crisis levels as central banks pumped money into the financial system.

Now, it seems the Fed would be less afraid if it saw investors being more afraid, or at least that is the new conventional wisdom.  That is a coherent view if the Fed knows that it doesn’t know what it is doing with the unwind of the taper and the like.  The Fed has private information that things may be screwy, but private investors don’t have that same information.  The Fed then thinks that investors might thus be overextending themselves and then the Fed gets worried all the more.

But is that, taken alone, a coherent equilibrium of beliefs?  Not yet, because it seems someone’s beliefs should have to budge.

So how does all this hang together?  The Fed doesn’t want to crush the market, it just wants to test whether investors might in fact have some private information of their own.  By “leaking” that it is worried about low volatility in the market, the Fed can see whether investors suddenly panic or whether they have a relatively firm basis for not feeling so worried.

And so far investors have not panicked, quite the contrary.  The relatively sanguine beliefs of private investors thus seem to have a fair amount of depth.  The Fed has nudged investors, to learn something about the shape of the response curve, and those investors have held their place or warmed to the data all the more.

So if you believe in rational actor models (a big if, admittedly), you should be bullish about asset prices looking forward.  Maybe about the real economy too.  We’re seeing lots of good numbers about credit for the United States and that is a significant leading indicator.


It is strange because all day long you hear about how crappy everything is.

The investor pool has shrunk considerably. Many of the weak hands shook out in 2008/2009 have never come back in. Stock and mutual fund ownership is at a low not seen since (I am guessing from memory) the 70s, despite Americans being increasingly dependent on personal savings via 401ks for their retirement.

The people that have held through the past 5 years and dollar cost averaged their way through it (like me) are probably not going to be shaken out easily even though there are a lot of worries out there. A good number of our clients sold everything at the worst possible time, and have dabbled here and there, but are basically waiting for the world to end before they dip their toes back in.

Based on yesterdays research paper, which found that when executives go on vacation there is lower stock volatility for there stock, it must be that more execs are on vacation and volatility will increase following their return from vacation..

Sometimes stocks go down, you know, something like 10% or more. It happens. It's been a while. It will happen again. And there will be no shortage of narratives.


It's different this time, right?

No, it's the same.

The headlines are wrong and most investors are missing out on the bull market.

They'll get in at the top.


Perhaps VIX is low simply because the volatility of fundamentals is low. I'm not saying that means the economy is "good" per se, but it seems like we are increasingly in a situation that is guaranteed to be mediocre rather than one that is 50-50 good or bad. The banks are slowly recapitalizing and the Fed has more or less put a backstop on low nominal and negative real growth, and add in a dash of good fortune that other risks seem to be muted at the moment, and you get very low vol.

In addition, corporate balance sheets, despite all the M&A news, are still pretty healthy by and large. The refinancing and extending of debt (I work in bonds) is mostly benign I think. So where would the vol be coming from?

This seems right. If people expect consistent mediocrity ('the McDonald's economy'), without much possible unexpected high side due to headwinds, and with the backstop against disruptive low side, then you get low volatility stability with a side of stagnation.

Until the robots replace everybody; then all bets are off.

Stocks will keep going up with small hiccups along the way that should be treated as buying opportunities. Despite its long duration and huge gains, the fundamentals of this bull market have not changed.

Perhaps after years of propping up asset prices investors have capitulated and accepted this reality. That, of course, could be a signal of a looming bear market. I don't know if it is still done, but there used to be an index of investor news letters. When they all went bearish, it signaled an upturn in the market. When everyone was bullish, it preceded a downturn.

Perhaps Vix is filling that canary in the coal mine role now. Or, maybe ummm is right and Utopia is just over the next hill.

Supposedly, trailing P/E ratios are somewhat high (@ 19.46), but they've been worse in the past. Looks like a 25% overvaluation. The Conference Board's leading indicators are still satisfactory.

There are enough insane P/E's out there to make for a nice little bear run. Amazon is Exhibit A. But, the broader market is probably just very stable as the economy remains in neutral. It is a strange time in that both terminal bears and terminal bulls are both right and wrong.

25% overvaluation compared to what though? Real estate? Bonds?

As the Fed has moved to taper this year, long-term interest rates have FALLEN by more than 0.5%. This is evidence in favor of a demographically-driven New Normal of low real interest rates rather than a Fed-engineered era of artificially low rates. Given this, higher than average P/Es on stocks are expected.

It seems rather obvious he is comparing current P/E to historic averages. That's pretty much the only comparison anyone ever makes regarding P/E and the broad market.

Since the 1990's, bulls have been dismissing P/E, but it remains a pretty good barometer of the market. Maybe things are different now, but just assuming they are is something you see before every collapse. Regardless, either the economy suddenly starts growing to catch the markets or the markets fall in the face of economic reality.

Now, it seems the Fed would be less afraid if it saw investors being more afraid, or at least that is the new conventional wisdom.

Or your reputation as a financial journalist is less injured by erring on one side rather than the other. These people have to write about something. Sometimes there's nothing to see there, but saying so is only attractive to journalists if they're trying to cover something up to benefit their sources, &c.

Perhaps the VIX is no longer an accurate fear gauge because it no longer measures what it once measured.

Actually the VIX is part fear gauge, part inverse of the S&P 500 index. With constant fear levels the VIX goes down when the S&P 500 goes up. These low VIX levels don't mean nobody's buying puts, they mean the market for puts has moved to higher price-level triggers, because the index is higher.

I don't understand any of this post starting from: "Now, it seems the Fed would be less afraid ..." Where are you getting these ideas about what the Fed wants?

The continued decline in fertility, which is normally correlated with the stock market (9-month lag), means this time is different. The stock market and economy are going in two different directions. One explanation is that growth is mainly coming from emerging markets. The S&P 500 is going up because of growth outside of the United States, not growth in it. Indeed, pick any multinational and look at the growth breakdown by region. That's why the market is up and yet the American public feels like this is a depression.

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