Traders have been complaining about a lack of volatility in the marketplace, mainly due to the constant flow of new money provided by the Fed and the bank of Japan. However, for a couple of days volatility is back. Is it here to stay or is it just a temporarily hiccup?
Since QE is flooding the market, every downturn in the stock market is seen as a chance to get in at lower levels. Especially the American indices, but also the Japanese and German indices, have experienced an enormous inflow of money the last six months. Low interest rates with excessive stimulus has chased investors into stocks. Look at the chart below what a plunging yen did to stock markets:
Because of the heavy machinery used by the Bank of Japan, the yen lost almost 30% to the dollar. Market participants used the cheap yen to buy all kinds of assets. Once again the yen-carry trade is in motion.
As a former Citigroup CEO once said: as long as the music plays, we dance. As long as the central banks keep spitting money, the indices will go up. But the million dollar question is of course: what happens when Helicopter Ben and his companions stop "printing?"
The official answer to that question is: nothing. Because the only thing right now that can stop the stimulus programs is a healthy economy with low unemployment. And once that point is reached, the stock market will be the place to be anyway.
But the time between that point and the current period of full stimulus will be a volatile period. Markets don't like uncertainty. Although it seems the American economy is getting back on track, the economic figures aren't all too bright. Yesterday for example, a reading of the ISM Manufacturing came in below 50, which suggests contraction ahead. And there is more:
- The ongoing sell-off in metals doesn't forecast a stronger economy.
- Rising yields on bonds suggest higher interest rates.
- The sudden decline of the Nikkei scared off stock investors.
- Unrest in Turkey, one of the best performing emerging markets.
Back to the VIX
The volatility-index VIX has been under pressure for quite some time now. In a previous article I stated that the VIX is actually not a reliable gauge for the volatility in the world markets since it only relies on options in the S&P500 index, which at the moment is more or less seen as a "safe haven."
But since mid May, the VIX has begun a slow but steady increase. I still think normal levels with the current turmoil should be around 18-20, but I have to acknowledge that the U.S. indices are less vulnerable than their counterparts elsewhere in the world. Uncertainty about more stimulus or tapering is needed to keep the VIX alive. Even a weakening economy could bring the VIX down since a weak economy would mean more stimulus.
People with a long position in VIX futures/options or ETFs/ETNs might finally be rewarded for their brave endurance. Clear evidence of a healthy economy is needed if the indices want to stay at this level without the drug money from the central banks. As long as that evidence is doubtful, the VXX might be a nice place to hide.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.