Why is Wall Street’s fear gauge so low?


After inflation fears shocked investors in the first few months of 2021, the markets shifted to another fad: deep sleep.

The Vix, a measure of the expected volatility of the Wall Street S&P 500 stock index, fell to a pandemic-era low of 15.7 points on Friday, after crossing 80 at the start of the pandemic. A measure of currency market volatility produced by Deutsche Bank also fell to its lowest level since February 2020 last week.

Analysts say the period of calm partly reflects the wait-and-see tactic of the Federal Reserve, which is prepared to sit on a period of unusually high inflation without removing monetary support, the withdrawal of which would likely disrupt markets. But some investors are increasingly worried that complacency is setting in.

“We are feeling more and more vigilant” about the calm conditions in the stock markets, said Gergely Majoros, member of the investment committee of European fund manager Carmignac. “It means you have to keep your eyes wide open for what’s to come.”

In a research note, the investment committee of Swiss bank Credit Suisse also warned of “a high level of investor complacency” in asset markets, suggesting there was “a downside risk. higher than usual for the information flow “.

Global stocks have hit record highs as economies in developed countries recover from the coronavirus emergency, boosting the outlook for corporate earnings. But the gains have been muted in recent weeks, with some investors saying the good news has been around for a long time. The FTSE All World gauge of developed and emerging market equities has gained just over 1.4% so far this month.

Headline consumer price inflation in the United States reached 5% in the 12-month period ending in May, following a 4.2% rise in April as prices linked to the reopening of the economy and supply chain bottlenecks – such as used cars and commodities – flew.

Central banks have traditionally tightened financial conditions to combat soaring prices. But the Fed, which is meeting this week, has maintained that the inflation explosion is temporary. He managed to convince many investors of this.

“The markets agree, at least for now, with [Fed chair Jay] Powell that the inflation we see is fleeting, ”said Margaret Vitrano, portfolio manager at ClearBridge Investments.

A Bank of America survey of 207 global fund managers responsible for $ 645 billion in client assets this week showed more than seven in ten believed post-pandemic inflation would be transitory. Many have also already reduced their bond holdings in the expectation of lighter support from the Fed to this market in the future, taking the bond share in portfolios to a three-year low. A negative attitude towards bonds is another factor that has convinced asset managers to hold onto stocks, investors said.

“Stocks are expected to rise again this year, but not at the same rate as when activity picked up faster earlier in the year,” said Caroline Simmons, UK investment manager in the wealth management arm from UBS.

Low volatility isn’t always a signal to sell stocks, historical data suggests. Figures compiled by Schroders analyst Duncan Lamont showed that since 1991 buying the S&P 500 on a day when the Vix was between 15 and 16 would have led to a total return of 14.6% over the next 12 months. .

But the sense of calm in the markets indicated complacency that could be shattered, analysts say, if inflation exceeds Fed expectations.

“If persistent inflation means higher input costs that companies cannot pass on. . . because household food and energy costs are also higher, which really affects profitability, ”said ClearBridge’s Vitrano. The stock markets “walked on water,” she said, “because it is too early to make a call on this.”

Currency markets have also been crippled by the prospect that the Fed will maintain financial conditions longer than traders initially expected.

FTSE All-World% Change column chart showing stock market gains slackening as investors believe recovery has peaked

The dollar index, which measures the strength of the US greenback against trading partner currencies, rose less than 1% this year, after strengthening in the first quarter and then relinquishing most of its gains since.

“The main story of inertia in [currencies] is fairly straightforward and emphasizes the stalemate between the compelling force of US reflation and the enduring purpose of an ultra-patient Fed, ”said Paul Meggyesi, head of global currency strategy at JPMorgan.

The Conference Board predicts that US economic output will grow at an annualized rate of 9 percent in the second quarter of this year and then slow thereafter. Corporate profits are expected to follow a similar path.

Analysts predict profits of companies listed on the S&P 500 will rise 35% overall this year, falling to 12% in 2022, according to FactSet. On the Stoxx Europe 600, profits are expected to increase 51% this year and 14% in 2022.

“The only direction the Fed and other central banks could take now is to reduce the accommodation, and that could cause correlation shocks,” driven by higher bond yields, said Olivier Marciot, cross investment manager -asset at Unigestion. “The markets are in a wait-and-see mode, it’s not about what happens next but when… If you move too early in the game, you will be beaten.



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