Could low volatility be a sign of bad things to come?
Is it time to worry? No, not necessarily. The VIX (CBOE S&P 500 Volatility Index), which is a commonly used measure of volatility for US large cap stocks, fell recently to a 52-week low of just 11.36. (The all-time low for the VIX is 9.31 on 12/22/1993.) As it fell, suggestions of a complacent market have become more widespread. Indeed, a low VIX can be interpreted as too much complacency or lack of fear in the market. Contrarians often use low VIX levels as a predictive sell signal. Conversely, a high VIX suggests a high level of fear and increased trading volume, often resulting in a period of market selling.
For comparison, lets look at annual high VIX levels since the recent recession: 2013 (21.91), 2012 (26.66), 2011 (48.00), 2010 (45.79), 2009 (56.65) and 2008 (80.86). We all remember the August 2011 debt ceiling crisis - that was the last time the VIX exceeded 40.00 - the S&P 500 fell almost 13% in August and September that year.
Why are the markets so calm today? Ultra-loose monetary conditions are certainly a big part of the answer. Tapering continues in measured steps and tightening is at least a year away. Corporate profitability is good, though US GDP growth slowed (or stopped?) in the first quarter of 2014. The US housing market may be staging a spring rebound. We continue to see political problems that individually,or collectively, could change things quickly. As I write this entry, the Ukraine crisis appears to be moving to a possible resolution and several key elections await in Europe.
Could some unexpected shock lead to a market sell-off or correction? Of course, that possibility always exists with or without low market volatility. We suggest that investors enjoy the calm, prune a few winners and have some cash ready should the right buying opportunity present itself.
