Investors Split on What Ultra-Low VIX Means for Markets

With a number of geopolitical risks in the rearview mirror, investors aren’t bracing for heightened volatility. But some Wall Street watchers warn that’s exactly why they’re skeptical.

The CBOE’s VIX index, Wall Street’s so-called fear gauge, plunged to a 1993 low on Monday, falling for 11-straight sessions – before trading slightly higher on Tuesday. Fueling the move lower has been a number of factors including Emmanuel Macron’s Sunday victory in the French presidential election, continued optimism over President Donald Trump’s fiscal policy efforts, slow but steady economic growth, and an upbeat first-quarter earnings season. At the same time, those drivers of low risk have also helped propel U.S. equity markets to fresh records.

“Everything is just sort of falling into an expectation mode,” said Ernie Cecilia, chief investment officer at Bryn Mawr Trust, which oversees $11.3 billion in assets under management. “There aren’t a lot of major concerns on a fundamental basis to move volatility to a higher level.”

Though unlikely, Cecilia pointed to a number of things that could lead to a tick higher in volatility over the course of the year including an unexpected geopolitical shock, a dramatic change in earnings or overall economic growth, delays in fiscal policy reform or a Federal Reserve that moves too quickly to reduce its $4.5 trillion balance sheet.

To that end, former Federal Reserve Governor Kevin Warsh, at Monday’s Sohn Conference in New York City, warned that not all risk has evaporated.

“I see risks highest when measures of risk are at their lowest…I would not take comfort, I would take fear,” he said of the VIX’s low level, adding that he’s keeping a keen eye on measures of economic growth, including corporate capital expenditures investments, which he sees as hard indicators of the U.S. economy’s health.

“If we see real businesses taking their cash flows and doubling down on investing in property, plants, equipment, then that’s a forward-looking indicator…the economy has room to grow. But if capex follows a similar refrain, it’s not clear the economy can strengthen. These are real indicators that will probably drive policy,” Warsh said.

The U.S. economy saw a slower pace of growth in the first three months of this year than it did during the final quarter of 2016. Investors have been puzzled by the divergence of so-called hard and soft data that indicate American business and consumers are upbeat about their economic prospects, but aren’t spending or investing at rates to match their optimism.

Still, business sentiment and capex plans remain “strong,” according to Dennis DeBusschere, senior managing director at Evercore ISI, as expectations remain for stronger growth in the next three quarters. Real business investment in 1Q rose by an annualized rate of 9.4% and was broad-based across sectors, according to data from the Commerce Department’s latest GDP report.

“The current ultra-low volatility environment looks increasingly unsustainable. However, with political uncertainty trending lower, there are fewer near-term catalysts to send the VIX higher,” he said.