State of the Market: In a departure from the past seven years, broad U.S. equity indexes are holding their ground despite a move towards tighter Fed policies, asserts Marvin Appel, MD, PhD, of Signalert Asset Management.
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Ever since the depth of the financial crisis, every time the Federal Reserve has backed away from quantitative easing, markets responded by destabilizing. For example, the chart below, left shows S&P Index Option Implied Volatility (VIX) and the size of the Fed balance sheet.
The black boxes highlight the three pauses in quantitative easing in 2010, 2011 and 2014 when the Fed’s balance sheet flattened and VIX spiked.
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Now we are talking not only about shrinking the Fed’s balance sheet, placing us in uncharted territory, but also about potentially four further hikes in short term interest rates between now and the end of 2018. Throw in the specter of war with North Korea.
Yet stocks remain unfazed and VIX remains near historical lows of 10%.
One thing that the stock market has going for it is the continuation of quantitative easing in Europe and Japan, which should mitigate the impact of the Fed moving in the opposite direction by attracting foreign buyers to take the place of the Federal Reserve. The economic growth outlook remains optimal as well: slow and steady, with limited risk of damaging inflation. Shorting the market in a low-VIX environment has not been a historically successful timing strategy, and I would not recommend bucking that trend.
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