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Stock market investors have spent vast amounts of effort this year worrying about why people are not worried enough. With gauges of expected market volatility touching new lows, a parade of bearish commentators have offered up warnings following the same consensus logic. Violent corrections, they say, occur when investors are complacent about risk.
Investors have been measurably complacent this year about risk, because volatility is low. Therefore, we are likely to have a violent correction. This week the VIX index, the most popular short-handed measure of market expectations for volatility for US stocks, has traded close to the lowest level since Bill Clinton was elected in 1993, prompting a further furrowing of brows from those exasperated at such apparently reckless investor relaxation.
Yet, is it really the case that investors in aggregate is so dangerously chilled out at a time when the S&P 500 is trading at a near all-time high? Real-world evidence of this complacency that so many people repeatedly reference is actually not that easy to find. In fact, large institutional investors, by some measures, are more nervous today than at any time since the dotcom bubble.
The most recent BofA Merrill Lynch fund managers survey, which polls investors responsible for managing almost $600 billion of assets, showed that 44% of the respondents said that equities today were overvalued, which is the highest number since 1999. These same nervous fund managers have actually increased the amount of their portfolios sitting in the safety of cash to 5%, a level above a ten-year average of 4.5%, and a reflection of their worry that US equity valuations have become dangerously overheated.
So taken at face value, these two indicators are highly contradictory. The entire justification for focusing on every minuscule move in volatility expectations is that the VIX provides a way of assessing market sentiment. Yet, if fund managers really are so worried, and one presumes that they're not lying in the survey, then the cost of options to protect against a correction, and therefore the VIX, should be higher.
Perennial pessimists may soon have to accept something even more worrying than all of this ongoing lack of worry, that their beloved VIX may no longer be a meaningful indicator of anything at all.
