In a year marked by geopolitical tensions, economic uncertainties, and an upcoming U.S. election, the stock market seems to be whistling past the graveyard. The Volatility index or VIX, often referred to as the "fear index," has sunk to levels not seen in nearly two decades. But what does this eerie calm in the markets really mean for investors?
Here we explore some of the key issues that we are watching closely with our investors exposed to the US equity market.
Record-Breaking US Market Highs Amid Concentrated Gains
The Nasdaq 100 has been on a tear, hitting 35 new highs this year alone. However, this impressive performance masks a concerning trend: the gains are increasingly concentrated in a handful of stocks. The percentage of S&P 500 stocks outperforming the S&P 500 Index over a rolling 21-day period has recently dropped to the lowest in history.
This concentration of gains in a small number of US listed stocks presents both opportunities and risks. While it's tempting to ride the wave of these high-performing stocks, prudent investors should consider the potential for a market correction if these leaders stumble.
Historically Low Volatility in an US Election Year
The VIX index, which measures market expectations of near-term volatility, has plummeted to levels below 13 for 11 consecutive days. This is particularly unusual for an US election year, where uncertainty typically drives higher volatility.
In fact, going back to 1992, the VIX has been higher than its current level of below 13 in every single election year. This abnormally low volatility might present an opportunity for investors to consider adding some protection to their portfolios. As history has shown, when volatility returns, it often does so with a vengeance.
US Economic Indicators Flashing Warning Signs
While the stock market continues its upward trajectory, several economic indicators are painting a less rosy picture. Both the ISM Manufacturing and Services PMI readings for June were in contraction territory, with readings below 49.
Going back to 1997, there were only 17 prior months when both Manufacturing and Service ISM indices were below 49. Of those, 15 occurred during recessions, and the other two occurred just after a recession.
Additionally, the June employment report, while appearing strong on the surface, revealed some concerning trends when examined closely. Full-time employment has fallen for six out of the last seven months and is down 1.2% year-over-year, historically an indicator of recession.
Small Business Struggles Continue
The National Federation of Independent Businesses' Small Business Optimism Index, while showing some improvement, remains in the bottom 13% of all historical readings. This persistent pessimism among small business owners could be a harbinger of broader economic challenges ahead.
The Federal Reserve's Balancing Act
Federal Reserve Chairman Powell has acknowledged "modest" progress towards the 2% inflation goal but maintains that more evidence is needed. This cautious stance suggests that the Fed may continue its tight monetary policy for longer than the market expects, potentially leading to increased volatility down the line.
The Hidden Risks of Low Volatility
While low volatility might seem like a positive development, it can mask underlying risks. Investors may be lulled into a false sense of security, taking on more risk than they realize. History tells us that when volatility returns, it does so with a bang.
DISCLAIMER
Royce Advisory Pty Ltd (ABN 43 622 402 706) is a Corporate Authorised Representative (CAR) of MB Capital Partners Pty Ltd (AFSL 536053). This article, commentary and discussion is general information only and is not intended to provide you with financial advice as it does not consider your investment objectives, financial situation or particular needs. You should consider whether the information is suitable for your circumstances and where uncertain seek further professional advice.
This communication is based on information from sources believed to be reliable at the time of its preparation (July 2024). However, despite our best efforts, no guarantee can be given that all information is accurate, reliable and complete. Any opinions expressed in this email are subject to change without notice and neither Royce Advisory or MB Capital Partners is not under any obligation to notify you with changes or updates to these opinions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.
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