The old saying “Sell in May and go away” comes from the seasonal weakness the stock market tends to experience between May and October. Historically, the stock market’s top performance on a six-month rolling period is from November through April.
In a June 7 Barchart article about the bullish trend in the S&P 500, I highlighted the bearish trend in the VIX index that send the metric that measures the implied volatility of put and call options on the most diversified U.S. stock market index to 14.04. In that piece, I wrote:
The VIX at the 14 level is far too low, given the potential events circling markets. The downside risk is low, and the upside potential could be explosive. A quiet summer would likely keep pressure on the volatility index, but any sudden surprises could ignite the VIX, causing it to explode higher in the blink of an eye.
I would only trade the VIX from the long side at the current level and happily accept short-term losses in the quest for substantial profits.
In late June 2023, the VIX remains around the 14 level, and I still believe it is far too low. Five factors can cause lots of volatility in stocks and markets across all asset classes over the coming weeks.
Factor one- Ukraine and China
The ongoing and escalating war in Ukraine and U.S. relations with China remain a clear and present danger to world peace. Increasing nuclear threats from Moscow, moving the weapons of mass destruction to Belarus, Chinese plans for reunification with Taiwan, and the challenge to U.S. military and economic leadership increase the potential for events that could roil markets and cause sudden volatility.
The geopolitical landscape is the most significant factor that could cause considerable surprises over the coming days, weeks, and months. Given the low liquidity across all asset classes, a sleepy summer in markets could become very volatile.
Factor two- Divisions in Russia
The Wagner Group’s recent challenge to President Putin could be the start of internal turmoil in the country with the most nuclear weapons. While many in the West cheer on the instability, the threat of nuclear weapons in the hands of irresponsible leadership or fractured government presents a clear and present danger to world peace.
While the Putin government put down the brief attempt, many Russians are tired of war, sanctions, and the increasing fatalities. The Wagner Group’s actions could be the first of many challenges derailing the Kremlin’s power. An unstable Russia could draw the U.S. and Europe into a more active role in Ukraine and expand the conflict beyond the current borders. The bottom line is the markets will not react well to a dangerous escalation that threatens world peace.
Factor three- A hawkish Fed
While the U.S. Federal Reserve left the Fed Funds Rate unchanged at a midpoint of 5.125% at the June FOMC meeting, the statement and press conference were hawkish. The central bank remains committed to pushing inflation to the 2% target rate; more rate hikes could be on the horizon. Several committee members forecast the rate to rise to over 6% to address the inflationary pressures. Moreover, quantitative tightening continues to pressure rates further along the yield curve. Tightening credit threatens to push the U.S. and other economies following the U.S. Fed into recession. As the markets react to a hawkish monetary policy path, sudden bouts of selling in stocks and other assets are likely.
Factor four- The U.S. political and economic landscape
The 2024 Presidential election season will kick into full swing in the fall with the country divided. The leading candidate for the opposition party faces a slew of criminal charges on state and federal levels. President Biden faces opposition from other Democrats, with RFK Jr. garnering double-digit support in the polls. The United States is not politically united, and the Chinese-Russian alliance could seek to take advantage of the disunity. China has been working with other countries to introduce a BRICS currency to challenge the U.S. dollar’s dominant position as the world’s reserve currency.
Meanwhile, the Fed’s interest rate hikes threaten an economic slowdown that could influence the upcoming election as the voting public tend to vote with their pocketbooks.
Factor five- Complacency
In today’s economic and political environment, complacency could be the greatest danger to markets across all asset classes. The VIX measures the implied volatility of put and call options on the most diversified U.S. stock market index, the S&P 500. The VIX tends to move higher during turmoil and bearish periods in stocks and lower when stocks rise. Since options are price insurance, the VIX rises when investors and market participants become nervous and buy insurance for portfolios. The VIX falls when the stock market is comfortable and complacent, as participants sell options to earn premiums.
The chart shows the VIX at below 14, and the recent low of 12.73 is the lowest level since January 2020, before the pandemic and war in Ukraine. The VIX at the current level is a complacency signal.
The summer tends to be a quiet time in markets, with low liquidity and sleepy price action. However, the economic and geopolitical landscapes remain highly volatile, and a reason surprises that cause sudden price variance is a clear and present danger as the markets head into the July 4 holiday weekend. Be careful in markets; the current calm waters could be the eye of a volatile storm.
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.
