Even amid the midsummer lull, more investors are hunkering down and preparing for a potential correction. As the S&P 500 Index continues its relentless grind higher, we think it’s worth considering proactive steps for a change in the environment.
US equity market volatility remains subdued. According to the Chicago Board Options Exchange (CBOE) Volatility Index, also known as the VIX, US stock market volatility hasn’t been this low in more than a decade. It might seem as though investors are complacent, but looking beyond the low VIX, we can see that is not the case. Beneath the surface, we believe that the volatility of the underlying members of the S&P is considerably higher.
SKEW INDEX SIGNALS RISK
In fact, the CBOE SKEW Index, another measure of investor fear, has been moving up. This index rises as more investors buy insurance for a downturn through out-of-the-money put options. This index reached a 90-day moving average of 136 before falling modestly to 133 at July month-end. As the index level increases from 100 to 150, there is more perceived risk in the market (Display).
UNDERLYING CONDITIONS ARE ROBUST
It’s true, the market hasn’t experienced a correction for a very long time. Valuations are elevated and US stocks have now posted nine straight years of positive returns, which suggests that a downturn is possible. That said, we believe that underlying market conditions are robust and that even if the market takes a leg down it would be a healthy correction.
Interest rates continue to support the market. Despite the Federal Reserve continuing to increase the fed funds rate, long-term interest rates remain low.
The recent recovery in oil prices and subsequent US dollar weakness are also helping. Both have pressured corporate earnings in recent years, but it seems that these headwinds are beginning to abate. The second-quarter-earnings season has been upbeat, with 77% of companies reporting beating consensus analyst estimates, as of August 4. And strong business conditions have triggered upward revisions to S&P 500 earnings-per-share estimates in recent weeks. To us, this scenario makes a strong case for US equities going forward.