The VIX Roared Overnight As Traders Worry About Trump
Axi | Jan 31, 2017 10:32
Originally published by AxiTrader h2 Key Takeaway/h2
The VIX has spiked.
But that's from levels close to 10-year lows.
Combine that with a market which was entirely focused on the lightness of Trumponomics and none of the darkness. Recent Executive Orders have lead to a reappraisal and some stock market selling.
What's next is an open question. But there is a good case to make that the S&P 500 needs to hold above 2250 for the current rally to remain intact.
h2 What You Need To Know/h2The stock market's fear index spiked 15% higher overnight as stocks in the US lost around 1% and fear of the impact of Donald trump's plethora of executive orders since taking office gripped traders.
Of course the fulcrum for the fear and selling in stocks and the US dollar (at least against the yen and Swiss franc) was the the public's visceral response to the president's immigration and travel ban. But this executive order seems to have ignited a focus on the dark side of some of the president's policies.
So traders took a little bit of money off the table, selling stocks and buying downside protection against a further fall in stocks. That's driven the CBOE Volatility Index - which measures implied volatility on S&P 500 index options - up around 15% overnight.
But as the past two years price action in the VIX shows this 15% means little in the grand scheme of things because it is a lift off a base which had seen volatility - during the Trump rally - fall to levels around the lows that the VIX traded to over the past 10 years.
That volatility spikes when stocks fall, put not when they rise, makes perfect sense.
Investors, and most traders, are by and large long only. That is, they buy and hold stocks but rarely sell them. That means they are only concerned with the negative side of volatility, when prices fall, and remain unconcerned as stock prices rise.
This is why the VIX is also commonly referred to as the "fear index".
But the big question this morning is whether last night's fall in stocks, and rise in the VIX, is a sign of more weakness and increased volatility to come.
In his study of markets Benoit Mandelbrot showed that volatility tends to cluster. That is, Mandlebrot said "large changes tend to be followed by large changes, of either sign, and small changes tend to be followed by small changes".
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In other words, volatility clusters.
But last night's move is a one off at the moment. It wasn't even confirmed with a move in gold back above $1200 an ounce in USD terms.
Certainly in level terms where the VIX fell too was ridiculous and priced the US stock market to perfection. That always opened up a chance for volatility to expand. Indeed another part of Mandelbrot's work is to show that volatility transitions from high to low and back again.
Hyman Minsky's Financial Instability Hypothesis at its core also explains in broad terms how an overly sanguine outlook can initially dampen volatility while at the same time increase risk.
So far we've had only one night of selling. It's the first material reappraisal of the Trumponomics rally in stocks since the surge higher began in November last year. And the president signed an executive order which has been an important plank underpinning the stock rally last night - that could act as a salve to the fear in evidence this morning.
That executive order relates directly to regulation and says "whenever an executive department or agency (agency) publicly proposes for notice and comment or otherwise promulgates a new regulation, it shall identify at least two existing regulations to be repealed".
That's a positive.
Equally though the surge in the S&P price to earnings ratio suggests there is some risk that bad news derails - perhaps temporarily only - the stock market rally in the US and beyond.
This tweet from financial research firm FactSet highlights the risk from elevated PE's.
Of course a big part of the rally has been an increased assessment of the E part - earnings - of this equation by analysts, traders, and investors. The regulatory ruling overnight is just the start of the policies that are expected to help achieve this, to improve corporate earnings and drive economic growth in the US.
Which I guess is all by way of saying the market rallied hard, on hope.
But the raft of executive orders from the oval office together with tweets, and belligerence, from the president since taking the oath of office have simply reminded markets that there is some darkness in Trump's policies and Trumponomics.
Withdrawal from the TPP, tariffs, trade restrictions, spats with Mexico (is China next), bans on those viewed as enemies of the US were all part of the policy platform the president took to the election.
So traders are just undergoing a reappraisal of the payoff between the positives and negatives of the new administration's policies.
That could take some time, or it could be a one day wonder. Time will tell.
In the meantime recognising volatility could continue to increase I turn to the technicals for the S&P 500 as a roadmap. To that end the 2250 level on the S&P 500 looks like important near-term support. A break would suggest another 25 to 50 point dip on my reading of the charts.
Have a great day's trading.
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