It has become one of the knottier puzzles on Wall Street.
As political risks have increased at home and abroad, complacency among investors has rarely been so widespread.
This
trend, which began soon after President Trump’s victory in November,
culminated on Monday, when the VIX index, known widely as Wall Street’s
fear gauge, dipped briefly below 10 — the first time it had done so in
more than 10 years, in the months before the financial crisis.
The VIX measures investor expectations that stock markets will move sharply up or down.
On
Tuesday, the VIX turned up, to close at about 10.6 — but still sharply
lower than its historical average of roughly 20. At current levels, the
VIX reflects a striking sense among investors that the persistent rise
in stocks would continue, regardless of election fears in Europe and
concerns here that Mr. Trump might not deliver on his ambitious economic
agenda.
“The
pricing of risk is at near historic lows, and the pricing of the stock
market is at near historic highs,” said Julian Emanuel, a stock and
derivatives specialist at the investment bank UBS. “And all of this at a
time when political risk is very elevated — at home and abroad.”
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Since
the VIX reached a recent peak of 22 in the days before the election in
November, it has fallen sharply as equity markets have rallied in the
belief that the president’s promises to slash regulations, cut taxes and
spend money on infrastructure would buoy the economy.
The
gauge generally moves in the opposite direction of the stock market. So
with the major stock indexes having hit highs, it would make sense that
the VIX would reach these unusual lows.
But what is less clear is why investors have been so willing to ignore so many outcomes that would send stocks reeling.
Mr.
Emanuel contends that what is driving the decoupling of increased
political risks and investor lack of worry is a rock-solid belief in the
market that the surge in so-called soft economic data (such as a broad increase in animal spirits among investors and businesses)
will be followed by better hard economic data — like a sustained
improvement in wages, investment and ultimately economic growth.
Market Calm
Despite the political turmoil in the last year, the stock market is sanguine.
80
60
40
20
0
10.6
2008
2011
2014
2017
CBOE Volatility index (VIX)
This
means that even as Mr. Trump has difficulties in getting his bills
passed, investors are not abandoning the stock market, but are switching
out of stocks tied directly to a Trump recovery, for example, banks and
industrial companies.
In their place, investors are loading up on other sectors, like technology. Consider, for example, the recent record close of the Nasdaq composite index with its heavy weighting in stocks like Amazon, Facebook and Google.
The net effect of this rotation is a stock market that goes up and a VIX that goes down.
“There
has been this epic disconnect between soft and hard economic data,” Mr.
Emanuel said. “And investors are just not willing to sell out of their
stocks right now.”
Russell
Rhoads, the director of education at the VIX’s home, the Chicago Board
Options Exchange, calls the high level of faith investors have shown in
the president’s promise to reinvigorate the economy the Trump put.
When
Alan Greenspan was chairman of the Federal Reserve, traders came to
believe that he would bail out a sinking market by cutting interest
rates, thus allowing them to take more risks — an approach that came to
be known as the Greenspan put. A put is an option to sell at a particular price.
Now, Mr. Rhoads says, investors are making a similar wager on Mr. Trump.
“We
used to have the Greenspan put, maybe it is the Trump put now,” Mr.
Rhoads said, citing a propensity of investors to stay in the market
despite political ups and downs. “He is so business-friendly — there is a
view that whatever happens he will do things that spur economic
growth.”
Unlike
a stock index like the Standard & Poor’s 500-stock index, the VIX
is not driven by stock prices but by the prices of options to buy or
sell the S.&P. For that reason, it is a forward-looking indicator —
30 days to be precise — that measures how volatile traders think the
market will be before the option expires.
One
reason for the gauge’s recent equanimity, Mr. Rhoads said, is that even
when investors purchase options to sell the S.&P. index at a
certain level (betting that the market will fall) to insure against a
sell-off, they are at the same time keeping their broad exposure to
stocks.
It is this tricky balancing act that has kept the VIX at these low levels.
Mr.
Rhoads, a student of financial market history, noted that the index is
what is known as “a means reverting vehicle.” This means that even if it
stays at these low levels for a while, the index will spike up when the
next bout of fear hits the market.
“It’s
like a rubber band that stretches and stretches until it pops,” Mr.
Rhoads said. “Everyone might be too confident right now.”
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