Friday, 3 March 2017

Fed Concerned at Lack of Market Volatility.

As a follow up to last week’s article regarding Trump’s trade policies, it seems we can now add the Federal Reserve to the list of worriers about investor complacency as stocks set new records almost daily (the S&P 500 has already gained 3.7 percent this month, posting seven record closes in the process).  Officials at the US central bank have recently expressed concern that the low level of implied volatility in equity markets appeared inconsistent with the considerable uncertainty attending the outlook for Donald Trump to deliver on pro-growth campaign policies.  This at least according to the minutes from the Fed’s meeting three weeks ago, which were released this week.
For now at least, stock turbulence has been all but banished from the market. The Chicago Board Options Exchange Volatility Index, a gauge of investor anxiety also known as the VIX, has been unusually calm in recent months. It’s less than two points above its 15-year low, even as the S&P 500 Index catapults to new highs. The measure rose 1.5 percent Wednesday, the first time it’s posted back-to back gains this month.
Fed members now join a multitude of market observers, analysts and investors, all of whom are scratching their heads over a consistently suppressed VIX.  Sure, optimism for economic fundamentals could be putting a cap on market volatility. But others see more credence in the Fed’s explanation, where stocks appear to be plotting their own trajectory based on policy expectations under President Donald Trump.  Take Trump’s upcoming address to Congress on Feb. 28, where he’s expected to reveal details of his tax reform plans.  It is possible that any delays in implementing the program could shake the market from its calm, particularly considering the questions surrounding U.S. relations with global trade partners which were discussed in last week’s article.
It seems that almost everyone is wondering why equity market volatility is so low given the uncertainty that exists.  Would-be tax policies, overseas concerns, relations with China are all potential pitfalls, and yet at least for now the waters remain eerily calm.  All of the quiet could make for a rude awakening, according to any number of analysts and fund managers alike.  Some have pointed specifically to the disconnect in expected volatility for stocks versus other asset classes. The VIX fell to a 19-month low against a gauge of Treasury price swings in late January, while the current ratio between the two remains 15 percent below its average since the start of 2014, data compiled by Bloomberg show.
In the minutes, central bank officials voiced concern about the pace at which the U.S. equity market has advanced.   Some believe that fast rising stock prices might reflect investors’ anticipation of a boost to earnings from a cut in corporate taxes or more expansionary fiscal policy which might not materialize, and there are those who feel this could spell disaster for the markets.   While it isn’t unusual for the Fed to comment on financial market conditions, taking a such a hyper-specific look at the stock market and volatility is notable.  However some investors remain optimistic, stating that even if policy doesn’t play out to investors’ expectations, healthy market fundamentals should support any momentary pullback.

This continues to be an area of huge importance to market performance for 2017, and it will surely be something that all investors will watch closely over the coming months as the world waits for Trump’s political intentions to be become more defined.  I remain of the opinion that the markets will see greater volatility as the year progresses, and am encouraging my clients to air on the side of caution until a clearer picture becomes available.

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