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In an August 29 Barchart article, I wrote:
The economic and political factors facing markets remain why the VIX will stay elevated, and the odds favor higher instead of lower levels for the volatility index for as far as the eye can see.
The VIX was at the 14.56 level on August 29. In a follow-up on September 7, with the VIX at 15.56, I wrote:
The current VIX level tells us that stock market sentiment remains bullish. However, stocks are in an epic battle against a hawkish Fed, and the geopolitical landscape increases the odds of bearish surprises. Risk-reward dynamics support a higher VIX, but a strategy and the discipline to stick to the program are critical for potential success.
On October 20, the metric that measures the implied volatility on put and call options on S&P 500 stocks was over 21.50, and it may still be too low.
Markets reflect the economic and geopolitical landscapes
While economic forces are a leading factor that guides market price action across all asset classes, geopolitical events can have an even more significant impact.
Historical volatility or price variance is an objective, backward-looking measure. Implied volatility measures the market’s sentiment about future asset price variance. In the stock market, the S&P 500 is the most diversified index. The VIX is a real-time indicator of the implied volatility of S&P 500 stocks.
In late October 2023, interest rates have risen to the highest level in years, with the U.S. 30-year Treasury Bond futures falling to the lowest level since 2007. While inflation remains a nagging problem with elevated consumer and producer price indices and robust retail sales, the tensions on the geopolitical landscape could cause the U.S. central bank to pause the hawkish monetary policy path to push inflation to the 2% level. Higher interest rates could push the U.S. into a severe recession while wars rage in Europe and the Middle East.
Two hot wars that divide nuclear powers
In February 2024, the war between Russia and Ukraine will mark its second anniversary. Neither side is backing down as the conflict continues to rage.
The October 7 tragic Hamas attack on Israel ignited a war in the Middle East. Israel continues to bomb Gaza as it prepares for a potential ground invasion. The U.S. and Europe have supported the Israeli response, but worldwide demonstrations have criticized Israel, protesting the answer has gone too far. Meanwhile, Iran and other countries in the Middle East have lined up against the Israelis. An intensification of conflict along Israel’s northern border with Lebanon where Iran-backed Hezbollah threatens to open another front. The West Bank is another area that could create a third threat to Israel’s sovereignty.
As countries worldwide line up with and against Israel, the potential for escalation is growing daily. Iran recently warned that U.S. support for Israel will “be held responsible for this situation.”
Iran is allied with Russia and China. The world’s nuclear powers have bifurcated since the February 2022 “no-limits” alliance between Moscow and Beijing. The situation in the Middle East threatens world peace and increases the potential for a third world war. Moreover, China’s reunification plans with Taiwan and a nuclear-armed North Korea only complicate worldwide tensions. Two hot wars and more than strained relations between the world’s most powerful countries are a toxic cocktail threatening a tragic outcome.
Division in the U.S. government
Another issue facing markets is the division within the United States. While the polls indicate a neck-and-neck race between incumbent President Joe Biden and former President Donald Trump. Even though former President Trump faces over 90 felony counts in multiple jurisdictions, according to the polls, he is running away with the Republican nomination. The race for President illustrates the vast division within the U.S. electorate.
Meanwhile, within the federal legislature, the division impedes any legislation. Former Speaker of the House Kevin McCarthy lost his position over the past weeks, and the slim Republican majority has not agreed on a replacement. The current candidate, Jim Jordan, did not have the vote to ascend to the speakership in the first and second ballots, creating gridlock.
The bottom line is division in U.S. government as worldwide dangers rise only complicates the geopolitical landscape.
Growing economic woes in the world’s two leading economies
In the U.S., inflation remains a nagging economic problem that could be beyond the Fed’s reach. The U.S. Strategic Petroleum Reserve is at the lowest level in four decades at 351.3 million barrels. The SPR was over the 600-million-barrel level in late 2021. The administration sold an unprecedented number of barrels after Russia invaded Ukraine to put a cap on oil prices. Meanwhile, the dangerous situation in the Middle East is causing oil prices to rise as OPEC countries and Russia control oil production and prices. Even though U.S. output has increased to 13.2 million barrels per day as of October 13, WTI and Brent crude oil prices are over $90 per barrel. Higher traditional energy prices support increased inflation. The oil market’s geopolitical dynamics could make the Fed’s 2% inflation target unrealistic in the current environment.
As the world’s leading economy is experiencing increasing economic woes, China, the second-top economic power, has also suffered from economic malaise. The wars, tensions, and trade issues only exacerbate the U.S. and Chinese financial issues in late October 2023.
Stick with the program- Small losses in search of significant gains
The bottom line is that economics and geopolitical are screaming that the world is becoming more dangerous daily. The VIX at the 21.50 level on October 20 remains too low in the current environment.
The long-term VIX chart highlights the rise from the September 12.68 low to the most recent 21.83 high. However, the volatility index remains low, given the current landscape.
I am a buyer of VIX and VIX-related products on price weakness, using tight stops and re-establishing long positions higher or lower when the price action stops me out. Since markets reflect the economic and geopolitical landscapes, the writing in on the wall and the VIX remains entirely too low in the current
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
