I’m concerned about the current low VIX reading for two reasons. One, September is historically a terrible month for market performance, and two, we have plenty of headwinds this year.Â
You’d expect market volatility would be rising or at least projecting some worry this time of year, but it’s not. September and October are often the worst months for stocks. Some of the biggest crashes in history have occurred in September.
Yet the volatility index (VIX) is sitting around 16 right now, which tells us that traders and investors are not worried about a pullback, sharp correction, or worse. (Historical trends show the VIX trading most of the month in the 20’s.)
Others may not be worried, but I am.
Why I’m concerned about the low VIX reading
A low reading means traders and investors are not pricing in risk, which could be just around the corner. Instead, everyone is all in. Any drop is a dip to be bought and any pullback will be shallow. The complacency is really mind-boggling, especially when you consider why.
This year’s bullish market performance has been driven by fantastic earnings results. In Q1, we saw some 50% gain in earnings followed by 37% gains in Q2. These numbers are eye-popping, moving the P/E multiple downward while supporting market valuations.
If this trend continues, earnings alone could continue to support great market performance. But that’s a big IF.
Inflation is expected to increase
The Iran War rages on, and it appears that oil supplies will continue to be throttled for months to come. That has put a nice bid under crude oil futures, now pushing well above $100 per barrel. Higher oil prices over a sustained period of time will continue to push inflation (and the price for just about everything) higher.
The Federal Reserve has been quite hawkish in their views recently, and everyone is expecting them to raise the Fed funds rate this month. The markets may not like it, but the lack of volatility is telling us not to be concerned about the consequences of higher rates.
Markets are not pricing in volatility for the mid-terms
It is widely believed that the Democrats will take control of the House and maybe the Senate. A close split could lead to a stalemate, which the markets generally approve of. But not pricing in any uncertainty is still unusual.
Two big events in December are looming
December is a big month. The final Fed meeting of the year will take place, and we could see another government shutdown. How will the stock market handle this uncertainty when it comes closer? I suspect we won’t have a 16% volatility reading, but stranger things have happened.
Take advantage of the low VIX
There is one advantage to having a low VIX: Option prices are cheap because the market is not expecting big moves to happen.
If you’re buying calls and taking profits, be sure to add in some inexpensive index puts as protection – just in case.
