Stock prices have rebounded with the S&P 500 Index (SPX) up from its December low, and the CBOE Volatility Index (VIX) has been offering relatively calm readings in recent weeks. But strategists say investors should look closely at five other indicators that may be flashing warning signs of turmoil ahead for the markets. Investors also should take note of the Investopedia Anxiety Index (IAI), which is registering a high level of concern about the securities markets among our readers.
Significance For Investors
The five signs of potential trouble are being registered by these indicators, according to analysts and strategists cited by Bloomberg: (1) the VIX of VIX (VVIX); (2) intraday stock price volatility: (3) VIX futures; (4) volatility of futures contracts on the 10-Year U.S. Treasury Note; and (5) low hedging costs.
The VIX measures expected price volatility in the S&P 500 Index during the next 30 days, based on analysis of trading in options linked to it. It is often called a "fear gauge" for the stock market, with higher values suggesting greater uncertainty and unease among options traders regarding the future direction of stock prices. The VIX of VIX (VVIX), meanwhile, measures volatility in the price of the VIX itself.
Mandy Xu, a strategist with Credit Suisse, sees dangerous complacency in the fact that the VVIX is near multi-year lows, suggesting that investors are expecting rather restrained movements in stock prices going forward. By contrast, Xu warns that the market is "vulnerable to bursts" of volatility in 2019, per Bloomberg.
When it comes to the 50-day moving average of daily price variations in the S&P 500, that indicator is at its highest level since December 2008, during the depths of the financial crisis. This points to rising risk, which may be heightened by the increased popularity of trading in weekly options linked to the S&P 500, according to Kambiz Kazemi, a partner and portfolio manager at Toronto-based La Financiere Constance.
Wide daily variations in the price of the S&P 500 mean that options contracts linked to it are more likely to hit their strike prices and be exercised. High open interest in such options contracts may spur a big uptick in hedging activity, which, in turn, "may contribute to abrupt accelerations in the underlying gauge," he says, per Bloomberg
Another warning flag may be VIX futures contracts, which are registering undue investor complacency about stock price moves four to six months ahead, per Stuart Kaiser, a strategist with UBS Group. He notes that their value has not been "meaningfully" above 20 for a significant amount of time.
Kaiser also is closely watching the volatility of futures linked to the 10-Year U.S. T-Note, which "now screens a touch low," he says. A sudden burst of interest rate volatility normally spurs a flight from so-called "risk assets," Bloomberg observes. Stocks and bonds alike are among those risk assets that are sensitive to interest rate expectations.
A less clear, but important gauge is the cost of buying bullish bets on the stock market, which now is exceeding the cost of buying downside protection -- as measured by difference between the premiums on call options and put options linked to the S&P 500. This can be interpreted as simply the result of revived bullishness, or, more ominously, as careless complacency, Bloomberg notes.
The Investopedia Anxiety Index (IAI), meanwhile, deduces our readers' degree of worry about the economy and the markets from an extensive analysis of the sorts of articles that are getting the most views right now. As noted above, the IAI indicates high concern about the markets.
Low volatility, and expectations of low future volatility, may be the rational result of calm in the market since the Federal Reserve indicated a more dovish stance towards future interest rate increases. On the other hand, as noted above, it also may be interpreted a dangerous level of complacency. A large number of major negative macro forces still abound, among them slowing global economies, rising inflation, and the unresolved trade conflict between the U.S. and China, all of which are curbing corporate profit growth.