In the aftermath of recent negative trade news, we expect VIX to stay elevated in the 15-20 range for December.
It's not only about trade, however: there are also economic pressures from manufacturing and possible spillover effects from Europe's struggling economies.
Meanwhile, the Fed is likely to stay on the sidelines, having delivered as many as three rate cuts in 2019.
The first two days of December greeted the market with a fresh round of volatility, with the VIX index spiking from its dormant 11-12 range into the 15-18 range. Our outlook for the overall month of December is 15-20. Below are six reasons that, in our view, account for this sustained level of volatility:
1) China Trade War Fears Rekindled: This one is a no-brainer. With China taking offense at the US pro-Hong Kong human rights bill and with President Trump raising the prospect of a trade deal being signed after the election of 2020, which essentially introduces another year of tariffs and uncertainty, VIX has nowhere to go but up. As a result, we have seen major indices, such as the S&P 500, Dow Jones, and Nasdaq, retreat from their highs and yield to volatility. Overall, we see VIX fluctuating greatly around the trade news in the near term.
2) Trade War Goes European and Even Latin American: In addition to the Chinese tariffs, which are arguably the most important ones, on December 2 the Trump administration announced $2.4 billion in tariffs on French products ranging from cheeses and beauty products to handbags and champagne. Tariffs came in response to the French digital tax, which adversely affects US tech companies, such as Facebook and Google. While the scope of these tariffs is relatively small (less than 1% of what was imposed on China), it is the trade war adversity that is at play here, not to mention the fact that these levies follow $7.5 billion in tariffs that the USTR announced in October on French wine, among other products. Separately, and perhaps not entirely unrelatedly, the United States reinstated tariffs on steel and aluminum from Brazil and Argentina. "Brazil and Argentina have been presiding over a massive devaluation of their currencies, which is not good for our farmers," the President explained his rationale for the Latin American tariffs. While less impactful on VIX than the bilateral tariffs with China, European and Latin American fronts in the trade war are certain to add their upward pressures on VIX.
3) Manufacturing Weakens Further: While representing only about 12% of the US economy, manufacturing remains under pressure, in part due to the ongoing trade war with China, albeit there could be more structural reasons as well. The ISM index for November has further weakened to the 48-49 range, which indicates continued contraction.
4) Germany and Great Britain Recently Dodged Recession Bullets: In November, we learned that both Germany and Great Britain registered GDP growth rates that were barely positive, albeit the two countries did escape the official definition of a recession (which is two consecutive quarters of negative GDP growth). The markets reacted positively, but the underlying problem did not go away: both Germany and Great Britain still have a strong chance of falling into a recession in 2020. Overall, soft European economy is eerily reminiscent of the dynamics from 2012, albeit at present we are at a much later stage of the bull market, which should keep VIX elevated.
5) No Immediate Fed Panacea: With three rate cuts delivered throughout 2019, we do not expect any more cuts in the foreseeable future, even if the trade war exacerbates. The Fed is currently in the wait-and-see mode, which means that the economy news need to become meaningfully negative for the Fed to start cutting again.
6) Impeachment Around Christmas: Last but not least - the House of Representatives is likely to impeach President Trump by the end of December. This is not new information and VIX has remained in the 11-12 range throughout November with that timeline in mind. In light of latest negativity, however, we may see VIX shooting higher for a day or two, possibly longer, once the impeachment vote actually takes place.
In summary, VIX historians will be quick to point out that VIX in the 15-20 range, as we are predicting, is nothing to fret about since the historical average for VIX is around 19-20. However, it is important to remember that the range we predict is judged against the low VIX environment of 11-13 from October-November. Therefore, an elevation to the 15-20 range is likely to be synonymous with rough markets.
Disclosure: I/we 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.