February 27, 2017
So far this year, the markets have performed pretty well, but you would not think so if your primary source of market information was the news coming out of Washington. I have never before seen such rancor and distrust in the political arena. There seems to be the media equivalent of a war taking place between the White House and most of the nationwide news services. After the bitterly fought Presidential election, there were hopes of a honeymoon between the political parties. Such hopes rested on both the new administration and the media “playing nice”. As we all know, that has not happened. Both sides have stayed on the attack since the election and there is no hint of compromise. How is this extreme political volatility affecting the market?
The standard gauge of market uncertainty is called the VIX index. This index has long been used to provide investors with a quantitative assessment of uncertainty in the market place. Historically the VIX index typically trades between the levels of 10 and 20. When the market moves above a VIX level of 20 it is believed that there is a lot of risk in the market. Conversely, when it is below 11 volatility is historically low and investors are not as concerned about market risk. The market is currently trading to a VIX level of 11.47.
Why is the market trading so well, with relatively low volatility, when the news out of Washington suggests a chaotic political environment? One explanation is that market players are looking past the ill tempered political shouting match to see a positive outlook for our economy. Perhaps investors are focused less on what they hear from DC, and more on what they see in the heartland. People have jobs, consumers are feeling confident in their spending, and investors seem willing to take some risk. The belief that tax cuts for both corporates and individuals are coming is still prevalent in investors’ minds. Moreover, news from around the world shows a willingness on the part of major corporations to attempt multibillion dollar mergers. Corporate executives and CEOs do not propose these risky deals unless they are confident in the outcomes for themselves and their share holders.
It appears that early 2017 has seen the development of two parallel, but seemingly unconnected, worlds of volatility. The first is market risk, as measured by the well known VIX. The second is focused on political volatility, which I will label PVIX. For now, our new PVIX index is very high. The market is currently saying that a high PVIX is not going to get in the way of an optimistic approach to allocating resources, making money, and investing. The market is firm and investors are feeling good about where they are.