The Elephant In The Room: "What Else Could Go Right?"

Tyler Durden's picture

Via ConvergEx's Nicholas Colas,

The equity market question of the hour is “When will U.S. stock market volatility return?” 


History tells us this is purely a question of “When and why”, not “if”.  A look back to 1990 – the starting point of the modern CBOE VIX Index – shows that domestic stock market volatility goes through distinctly pendulum-like movements that takes years to develop. The daily VIX can run annual averages below 15, as it did from February 1993 – September 1996 (43 months), February 2005 – October 2007 (32 months), and August 2013 to July 2015 (23 months).  Once the annual VIX average crosses 15 to the upside (as it did on July 13, 2015), it typically spends years above this level and can average +20 for much of that time. 


So for all the chatter about low actual/projected volatility at the moment, that’s where we are now. The pendulum is swinging, albeit slowly, back to higher volatility.  That explains the “When”: it is already happening.  As for the “Why”…  We’ll find out soon enough.

Fill in the blank:

“U.S. equities are currently showing little price volatility because ______________________”

I took a poll of friends and coworkers on the buy and sell side for some answers, and the most comprehensive one came from Pete Coleman, our own head trader at Convergex.  His answer:

“… stocks are fully/fairly valued, economic growth is slow but positive, and interest rates are low but not heading much higher.”

Let’s take a quick turn though each of Pete’s points:

#1: Full Valuation.  According to FactSet, the current bottom up earnings estimates for the S&P 500 for 2016 and 2017 are $119/share and $134/share, respectively.  With the index at 2180, that works out to valuation multiples of 18.3x and 16.3x, respectively.  Top down earnings estimates for next year are understandably lower (strategists can cut numbers without ticking off company managements, unlike the single stock analysts that feed the bottom up estimates) at $128/share for a 17.0x multiple.


Now, no one is a point smart on P/E multiples, so 17x and 18x are essentially the same thing.  But keep in mind that S&P 500 earnings have not grown in 3 years and that makes paying a rich multiple on this market something like plunking down Gucci money for Wal-Mart store brands. There’s nothing wrong with Wal-Mart, or Gucci for that matter, but you want to see value commensurate with quality.  The best thing you can say about U.S. stock valuations is that they are “Fair”.  And by that we mean that enough investors see the same value that volatility is low as a result.


See the most recent FactSet report here (it’s free, very complete, and up to date):


#2: Slow Economic Growth.  First half GDP growth in the U.S. has averaged 1.0%. Retail sales (July) are running 2.3%.  Light vehicle sales stopped growing 18 months ago, albeit at high levels.  Personal savings rates (5.7% in July) are double pre-Crisis levels (late 2007).  New home sales have picked up, but existing home sales have stalled (like autos, at high levels, but not rising).  August ISM survey results were 49.4, below the 50 line that denotes contraction. Labor market data has been fine, but productivity declined 0.4% in Q2.  Core CPI (+1.6% in July) and PCE prices (+0.8% in July) are still below the 2% Fed target.


On the bright side, such as it is, the Atlanta Fed’s GDPNow model of future economic growth is calling for 3.5% in Q3, well above the Blue Chip consensus of 2.7%.  This model is best used later in the quarter (ideally, 30 days before the first release of the data), but we are 2/3rds of the way through and the model is still remarkably sanguine.  So there is some hope that the back half of 2016 will play catch up after a weak first half.


See the Atlanta Fed model here:


And the Richmond Fed’s excellent slide deck on the U.S. economy here:


#3: Low and stable rates.  It isn’t just the equity market with a case of the yawns; 10 Year U.S. Treasuries have traded in a tight band of 1.40 – 1.60% since mid-July and the spread between 2 and 10 Year U.S. sovereign debt has been 0.76 – 0.90 over the same period.  Yes, that 2-10 spread has been tightening this year but we’re still far away from the zero point where recession becomes a real possibility.


Just as importantly, markets of all stripes (stocks, bonds, currencies) are locked into a “Fade the Fed” mentality that heavily discounts the possibility of a rate increase before the December meeting.  Fed Funds Futures currently place only an 18% chance on a move to 50-75bp at the September 21st meeting and little more than a coin toss (52.4%) at the December 14th FOMC meeting. 


See the CME Group’s FedWatch Tool here:

In short, Pete’s explanation has all the necessary components – cash flows (earnings), economic outlook (sustainability of those earnings), and interest rates (the discount rate for those cash flows) – to make for a useful framework.  Market participants have sufficient confidence in each leg of this stool to comfortably sit on their stock portfolios.  The big question now is “How long will that confidence last?”

To get a historical perspective on prior periods of similar low-volatility market behavior, we pulled the daily data for the CBOE VIX Index back to 1990.  Since the VIX is closely tied to actual volatility, this is a useful measurement of both current price action and expected near term moves in the S&P 500.  To get a sense of “Structural” volatility expectations through time, we ran a historical one year average VIX level using the daily close for the VIX.  The chart with our findings (1991 to present) is in the attachment to this note, and here is what the data tells us about prior periods of low actual/expected volatility:

Even though the long run average of the VIX is 20 (19.74013, to be exact), there are long periods of time when it can trade consistently below 15 on an average annual basis. That’s not quite one standard deviation (that is 8, or 7.9867 if you want to be precise), but far enough away from the long run mean to be noticeable.


The three times this has occurred since 1990 are:


  • February 1993 to September 1996, when it averaged 13.4 over this 43 month period.
  • February 2005 to October 2007, with an average of 13.2 over 32 months.
  • August 2013 to July 2015, with an average annualized reading of 14.4 over 23 months.


Once the annual average VIX crosses back over 15 on its way higher, it is years before this measure of volatility begins to decline again.


The picture here is essentially one of a pendulum of market volatility, swinging back and forth in very long movements.  Volatility can remain suppressed for years, and we outlined 3 periods where average annual VIX readings are consistently below 15.  The last one of these ended a little over a year ago.  Yes, it may feel like we are still in it (today’s VIX close was 12.3) but recent bouts of market churn (China last year, Brexit earlier in 2016) are holding those averages above 15.  Today’s one year average, for example, is 17.2.

As to where we go from here, the historical patterns are clear.  We had our run of low volatility and it ended last year.  We are now in a new phase where volatility will rise.

The logical question is, of course, “Why?”  Prior periods of low average VIX readings did not always end badly, with equities rallying from 1996 to 2000 and from July 2015 to the present day.  Still, coming full circle to Pete’s comments – fair/full valuation, a slow economy and low interest rates all supporting stocks – it is harder to make the bull case.  What else could go right?

Which leaves the opposite question as the elephant in the room: “What could go wrong?”

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Dr. Engali's picture

"Interest rates are low and going much higher."

Bwahahahahahahahaha..., I think I just peed a little.

I have news for you pal, rates are going negative. Your "analysis" is a bunch of crap if you can't recognize that point.

Yen Cross's picture

 Rates are going lower for the banksters Doc.

 They're going higher for everyone else.

JamesB's picture

Engali:  I think you misquoted him. He said rates are "not going much higher".  Bladder control is easier if you read it correctly.

"Not going much higher", and "falling rates" aren't mutually exclusive.

hp-source's picture
hp-source (not verified) Dr. Engali Sep 11, 2016 10:34 PM

My last pay check was $9500 working 12 hours a week online. My sisters friend has been averaging 15k for months now and she works about 20 hours a week. I can't believe how easy it was once I tried it out. This is what I do...

The Real Tony's picture

Pete Coleman is one sick puppy, presently stocks are the most overvalued in history.

adanata's picture


Stocks are fully/fairly valued? Wow. Insiders out for almost a year? What could go "wrong"? Let's see, since they're just propping it up waiting for political expediency and a scape goat.... Trump 2016!

Turin Turambar's picture

VIX isn't going anywhere the coordinated cb's don't decide its going.  How many years of monkey-hammering VIX manipulation does it take before these financial dolts finally get it?


U4 eee aaa's picture

Oh they get it. They, just like the MSM on Hillary, are not going to admit the 'health' problems until the market keels over in front of everyone

Citizen_x's picture

VIX, in mid April, 2016 began trading pre-market.

Usually it opens when DAX opens open for the

trading day.  I do not know if this can play a

factor in the historical charts mentioned in this


Cybloom's picture

Anyone remember the crazy BREXIT market reaction! Would not surprise me to see new all-time highs soon. 

Yen Cross's picture

 I don't mean to piss on anyones parade, but I'm going to buy some more REAL silver bars today.

 Looking at the hourly chart and the Fed front running, I feel it prudent to pick up another 250 ounces.

  That's how it's done Bitchez

blue51's picture

Let me guess. 50 of those cute 5oz'ers you enjoy ?

Yen Cross's picture


 I'm also going buy some more gold . It's oversold

dark pools of soros's picture

nah sell gold for platinum right now

Oldwood's picture

So, we are still trying to predict future economics by looking at the past?


I guess we still have not comprehended the problem here.


THERE IS NO ECONOMY, at least not an economy anything like the past. World governments and their central banks have unprecedented power to manipulate and distort. Yes, at some point it will collapse, but it will not be predicted by some gambler looking for profits.

adanata's picture


We know that.... but you have to work with whatcha got while you got it... yeah?

The Real Tony's picture

Pete Coleman must have just crawled out of a cave, stocks presently are the most overvalued in history.

. . . _ _ _ . . .'s picture

"The best thing you can say about U.S. stock valuations is that they are “Fair”.  And by that we mean that enough investors see the same value that volatility is low as a result."

Convince enough suckers, control everything. Life as a cult.

Flocks of sheep, not just one but many many groups of flocks of sheep.

They're blowin' it for the rest of us non-psycho/sociopathic, generally peaceful, hard-working folks.

The economy, nukes, disease, war... something's gotta' give, because of their delusions, and we'll have to foot the bill.

But we can't feed ourselves without them, and they are most definately tightening the noose. The leash is getting shorter, and ironically, they are effectively out of reach.

They don't care about the EU any more, so they let Brexit happen, meh.

The unpacampaign is gonna' win (read the home page as it originally appeared.) The United Nations HQ will be in Asia, probably Astana.

"Call for global democratic oversight of international financial and economic institutions

Triggered by the global financial crisis, the world community faces a huge social and economic disruption. The achievement of the Millennium Development goals is seriously threatened. The poorest in the world are those most affected. Potentially grave repercussions on political stability and democracy are to be feared. The situation requires rapid and effective global responses. An appropriate institutional setting has to be set up to regulate and re-orient the financial system."


"We call on the United Nations and the governments of its member states to support the establishment of a United Nations Parliamentary Assembly in their deliberations on the reform of international monetary, financial and economic institutions. We urge the Commission of Experts on Reforms of the International Monetary and Financial System set up by the President of the UN General Assembly to consider the proposal and to express its support. We call for all organizations, decision-makers and citizens engaged with the global common interest to support this call."


WFM  (At the bottom it says "UN reform")

World Federalist Movement Funders

Welcome to the 'eighth world'. All because of C students... the majority.

It explains Bieber.