Stock Market May Be Underpricing Volatility Risk

November 15, 2017, 4:00pm EST

BR caricatureStocks were broadly lower today. Bond yields were lower. Commodities were mostly lower. And the VIX, the index that measures investor demand for protection from a decline in stocks (also known as the “fear index”), was the biggest mover of the day. But it’s rising from a low base.

As you can see in the chart above, the VIX was under 10 (very near record lows) at the close on Friday, November 3. That weekend, we got the news that the future Saudi king had directed the arrests of corrupt Saudi royals, ministers and investors (including billionaire Alwaleed bin Talal).

So you can see the rising VIX as we’ve seen the growing signs that there may be some forced selling across markets related to those arrests, and the Kingdom’s pursuit of hundreds of billions of related assets.

Still, for perspective, you can see how low the VIX remains, relative to history.

This shows you how the market has been lulled to sleep–underpricing the prospects of volatility. If you look back over time, you can see how quickly that can change.

Still, a market event doesn’t mean an economic event is occurring. The economy is good. And with stimulative fiscal policy coming down the pike, it should be better over the next 12 months (and coming years). So there is a difference between volatility and recession risk.

On that note, in the next chart from the NY Fed, the Treasury market is telling us recession risk is very low–9% chance in the next 12 months).

And the difference between high grade corporate bonds and the U.S. Treasury yield tells the same story–very low recession risk/probability of economic hiccup.

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