Not even a lone trapper in the Alaskan wilderness could have missed the fact that markets are at record highs, after pushing through numerous previous records. The markets closed Friday (11.10.17), after a small pullback at 23,422 for the Dow, 2582 for the S & P, and the NASDAQ at 6,751.
Higher closes are possible, perhaps likely. But a pullback is also inevitable. Whether the pullback comes in stages, or is a massive correction, is not completely predictable. But a factor relevant to the run up, and likely the pull back, is record low volatility.
VIX is not the Nick Name for the Fourth Reindeer
The Chicago Board Options Exchange (CBOE) VIX VIXis a measure of the expected volatility of the S & P 500 for the next 30 days. It measures implied volatility, or what the market predicts.[1] It is sometimes referred to as the “Fear” index. It reflects investor sentiment. It formerly has predicted decreases in the S & P.
The VIX has remained generally low over the last few months. Historically, a VIX value of ten is very low. But recently, the VIX has spent much of its time below ten, sometimes falling as low as eight.
The VIX has seen a spike or two recently. A recent spike happened on November 9th, likely due to concerns that the republican tax plan would be delayed. One can expect a volcano if it appears that the tax bill will not be passed, or only minimal parts of that proposal are passed. *
Where there is Momentum, There is Money. Where There is Volatility, There are Ways to Make Money
When markets move, either way, traders make money.[2] When markets reach stratospheric heights based upon discounted events, a substantial pullback is likely based upon the occurrence, or nonoccurence, of such event. So news of the collapse of the tax plan could send markets reeling. Investor sentiment of the possible failure of such tax plan may be presaged in the VIX.
Commentators have also noted that because the VIX does not include world markets, it is limited in its ability to gauge investor sentiment. Others think that the VIX is being heavily shorted, effectively keeping the index low.
Get out Your Old Financial Economics Textbooks
Finally, some believe that Fed monetary policy is uber-transparent, allowing market participants “real time” information about monetary policy and permitting market participants to anticipate and react accordingly. This essentially creates a feedback loop where the market and the Fed match move to move. Market events are ostensibly discounted and the Fed is extremely accommodating.
Investopedia Investor Anxiety Index (IAI)
The IAI is a broader, although less technically validated, index. It is based upon the sentiment of Investopedia readers worldwide. It captures three data points, macroeconomics, investor, and debit and credit sentiment. A reading of 100 on the index is considered neutral. The index currently stands at 101.9, very close to neutral.
Historically, October and November are the worst months for the markets. We are nearly one-half way through November, but those historical markers may not mean too much in a market like this.
EVERYTHING IS DISCOUNTED, EVEN THE FIVE FINGERS, IN THE DESERT OF THE REAL!
* Although this is not generally a political blog, tax modifications, euphemistically called "tax reform," are merely grand plans for the operation of government, as artfully described by the late political scientist Harold Laswell, as "Politics: Who gets what, when, and how." This tax bill is a massive tax cut for wealthy business owners that own pass-through entities such as LLCs and LLPs. Lowering the corporate from 30% to 20% sounds meaningful, and may have some salutary effect. But since the effective US corporate rate is 18.8%, this piece of the bill is a canard. It provides modest tax relief to many middle income tax payers, and raises taxes for others. But the bill also zeroes out popular benefits for politically "weak" constituencies. In the Author Rob's personal view, he hopes the bill fails. The market will tank and he will clean up selling short positions. And a great injustice will be avoided.
[1]
Implied volatility is also a relevant value for options. Implied volatility
will aid an options trader in determining whether the option is more likely to
fluctuate in price than other options. Remember, however, volatility is not a
directional indicator. It only predicts price movement.
[2]
Actually, there are ways for traders to make money in flat markets. But that is a topic for another day.
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