You'll remember that we've visited the subject of the CBOE's Volatility Index ..... a.k.a. the VIX ..... a.k.a. the Fear Index ..... a number of times in recent weeks and months. In particular, our attention was drawn to the startlingly low levels of volatility, the lowest in decades, at a time when stock markets were repeatedly making record highs. It seemed reasonable to highlight the concern that such a combination suggested a degree of complacency on behalf of investors that might not be entirely healthy. Others were keen to put it more strongly ..... the markets, in blinkered bullish mode, were in danger of sleepwalking into a nightmare against which they had taken no protection.
A bit melodramatic ? Possibly ..... but whatever your view it's still difficult to understand why levels of volatility have been quite so low in these circumstances. Given that the VIX is calculated from the cost of options that offer insurance (or protection) against moves in the S&P 500 Index, recent levels of below 9.50 -- the lowest since 1994 -- certainly pointed to a level of confidence in sky-high market valuations that some might call rash. It's not as though there haven't been economic hurdles to be overcome, and as for political developments that might normally be expected to cut the legs off stock market rallies ..... ? The markets have been able ignore the US administration lurching from one crisis to the next, and its inability to implement intended policy, as if it never happened ..... if only !
In the last few days, the VIX has traded up to just shy of 17.0 -- not a stratospheric number historically, but by recent standards that's quite a hike. So what, finally, has caused investors to admit to themselves that there are some clouds on the horizon that really do require their attention ? No prizes for guessing that the answer is North Korea, and volatilities in many east Asian markets, particularly currencies, are trading a fair bit higher than the VIX.
Now, we need to keep things in perspective. Most respected judges of these things are of the view that there is very little chance of actual conflict. But frankly, given the personalities involved, it's only natural that one might be a little concerned .... and from a market point of view, only sensible to consider some protection. Let's face it, as Ray Dalio of Bridgewater Associates suggested yesterday, what we have here is one huge game of "Chicken". Bearing in mind how high the stakes might turn out to be, that's not good ..... and what's more, it's a game of chicken being played between a militaristic, bombastic paranoid with historically no interest in diplomacy on the one hand, and Kim Jong Un on the other.
So that's what it's taken to bring on a spike in the VIX, and the ratcheting up of the rhetoric has had other predictable effects that we normally associate with times of trouble and flight-to-quality -- the return of a "RISK-OFF" environment, if you like : the first reversal in equities that previously seemed impervious, buying of top quality government bonds like US Treasuries and German Bunds (prices up / yields down), a move into currencies perceived as safe-havens -- Jap Yen and Sw. Franc, and of course some renewed interest in the most traditional haven of them all ..... gold.
As we say, you would expect these moves in a risk-off situation so there's not that much to say about them ...... EXCEPT three points of interest that may or may not be entirely unrelated to the current issue under discussion :
If you ever wonder how far moves in central bank rates automatically transfer down the yield curve, take a look at 10yr US Treasuries : as we write they are yielding 2.19% , a fraction LESS that they did in Dec 2015 just before the first of FOUR Fed rate hikes.
The Jap Yen is the ultimate safe-haven currency because of Japan's large current account surplus and net foreign asset holdings. Switzerland also has a massive current account surplus, but the franc's gains may be tempered by Swiss National Bank intervention .
Gold -- always fascinating even if it flatters to deceive too often for some tastes . The same Ray Dalio of Bridgewater Associates -- the world's biggest hedge fund -- yesterday advised money mangers to put 5 - 10% of their funds into gold. It's about North Korea of course, but also about the rising odds of US Congress failing to raise the debt ceiling when they come to vote on it, probably next month. According to Mr Dalio, such a development could theoretically lead to a technical default, a temporary government shutdown and a loss of faith in the effectiveness of the US political system.
Aha , there he is ! If you're after something or somebody to give the Fear Index a goose, perhaps Mr Dalio's your man .....