Investors have grown ever more optimistic about the future of capital markets, despite geopolitical turmoil from the Britain’s decision to leave the EU and France’s tumultuous election. Since Sunday’s election in France where Macron the centrist emerged victorious over his far-right rival Le Pen, market volatility has begun to quell as thoughts of a major market sell-off have all but died amidst the relatively neutral minded Macron showing support for France in the EU. As it stands the CBOE Volatility Index, VIX is at its lowest level since 1993, while both the S&P 500 and Nasdaq composites hit new highs Monday.
According to chief executive officer of Swan Global Investments, Randy Swan, “People are not worried about a market selloff.” He believes the market is primed to rising for the next several months. However, others have looked to the shorting of the VIX as an indication of complacency amongst market participants, which had led some investors to pursue other complex financial instruments to help protect against a potential shock in equity markets. Former Federal Reserve Gov. Kevin Warsh warned investors that market risks have not vanished, and strongly recommends that asset manager and trader alike hedge their exposure.
The VIX is based on prices of outstanding option contract on the S&P 500 index, designed to measure investor expectations for market turbulence and assist portfolio managers in hedging against bullish wagers. Since 2008, the VIX has become of the most widely observed financial metrics on Wall Street, after reaching an outrageous 80.86 in November of that year. According to Goldman Sachs Group Inc, more than 40 ETFs track the VIX accounting for more than $3.7 billion in AUM amidst the growing popularity of futures and options as leveraging tools to bolster profits and boost returns.
The direction of the VIX points to greater investor confidence despite questions regarding President Donald Trump’s potential growth objectives for the economy. Recent quarterly profits released by U.S. companies show profits reaching five-year highs, alongside an increase in the number of jobs added to the economy (211,000) in April. These positive signs have allowed investors to pool money into large equity funds and ETF’s on the assumption that stocks will appreciate in the near future. In addition, much Geopolitical risk has begun to ease, with the victory of Mr. Macron bringing a sense of stability to markets.
However, some investors still remain skeptical regarding the effectiveness of the Trump administration in its ability to deliver on some of its broad promises to overhaul the tax code and re-invest money into infrastructure. Kevin Kelly, chief investment officer of iRecon Capital, argues that the VIX is not a great indicator of market direction, stating “It’s absolutely not the perfect insurance.” Yet, while some doubt the optimism present within the market, those found shorting the VIX have lost 45% this year thus far, while those going long have been winning, gaining 69% in 2017.
Thus, as investors benefit from an appreciating stock market the emphasis on their hedge not paying off is placed on the back burner. When the VIX is at very low levels, it is less likely to move alongside moves in the stock market as a whole. According to CBOE data, the VIX and S&P 500 have moved in opposite direction about 80% of the time, indicating little room for a price correction. It is important to note that prolonged periods of low volatility, may simply be the “calm before the storm,” even though the calm may last quite a long time. However, we will have to see how the market plays out moving forward if we are to make any definitive conclusions.