The market’s volatility index or VIX hasn’t been this low since 1993.
The VIX is also known as the market’s fear gauge. It is usually around 20, but nowadays it’s about half that.
Some argue that the VIX isn’t a good judge of the market now because of all the central bank meddling since the crash. That because the central banks have been artificially supporting the markets, there’s going to be less volatility.
But even if that is true, it begs the question, why, now that the Fed has decided it is going to raise rates and sell off most of its accumulated reserves, has the VIX has actually gone down, not up. Also bear in mind most of the world’s major economies have stopped priming the pumps through their central banks as well.
And yet volatility — fear — is at record lows. There are articles about this odd place we’re in across the media. Most are reaching the same conclusion: This isn’t a bullish sign.
You may have heard the terms “risk on” and “risk off” buying. These are traders’ terms for the overall feel of the market.
If the markets look risk on, that means it’s a good time to be buying stocks and reaching out on your risk profile to pick up riskier shares. If the markets are signaling risk off, then you stick with conservative stocks and look to bonds.
Right now the markets are solidly risk on. And why not?
The U.S. victory by Donald Trump and the Republicans has been a shot in the arm for a pro-business agenda. Domestic oil production is back on track; unemployment is low, consumer spending is alive, if not vibrant. Earnings are good. Tax reform is moving forward, which will help a number of industries.
France’s recent election of Emmanuel Macron stabilizes the European Union and is also a pro-business sign. His opponent, Marine Le Pen would have destabilized an already struggling Europe, which would have serious economic consequences in the U.S.
Brexit seems to be going well for the U.K. Japan is back on its feet, although it’s still a bit disoriented. A new South Korean president is talking about working things out with North Korea.
Why wouldn’t it be bullish or risk on?
The elephant in the room
While all this feel-good risk on buying sends the Dow and S&P 500 higher, there are some weird things are happening in China, the No. 2 economy in the world.
Its main stock market in Shanghai is down 5 percent over the past month. There’s some serious issues with corporate lending — the Chinese bond market has dried up.
Now that could be seen as an encouraging sign. The companies are focusing on living within their means and not extending themselves any further in this dangerous cycle of artificial, government-driven stimulus.
But it could also mean that the banks, shadow banks and corporations are so leveraged that they’ve run past the edge of the cliff and right now are looking down to see they’re in mid-air.
Chinese exports and imports were both down last month. Commodity prices have crashed, especially iron ore and copper.
Iron ore is the world’s most commonly used metal. It is the foundation of steel. If ore is cheap, then demand for steel is low. Low steel demand indicates that the economy is not growing.
Copper is also known as Dr. Copper, the metal with a PhD in Economics. It holds this title because copper is historically an excellent indicator of recessions.
Copper has dropped from $2.60 a pound to $2.48 a pound in the past week. It’s gone from $4 a pound to $2.48 in the past five years.
Flagging iron ore prices and flagging copper prices are a strong signal that China’s comeback is far from assured.
Ten or 15 years ago it wouldn’t have been such a big deal in China went into recession — or worse. But today, it’s a massive economy that affects the entire global economy.
And if these fundamental issues aren’t giving you flashing red signal, then notice that the price of bitcoin has hit all-time highs. Some of this is because Japan has made bitcoin an official currency, but much of it is because more and more Chinese are offshoring their money because they’re losing faith in the yuan and the banks.
It’s very difficult to get money out of China, so they have to be very creative and stores of value like precious metals and bitcoin are the way they’re doing it. For those wealthy enough, they’re buying real estate around the world.
For Chinese corporations, they’re buying Western companies to offshore assets if need be. The recent $43 billion buyout of Syngenta by ChemChina is the most obvious example.
Conclusion: Risk off
When things get this confused, it’s not a good idea to amp up the distortion by buying aggressively.
This is the time to back off; go risk off.
It means sticking with midstream energy companies like Williams Companies and Enterprise Product Partners, or oil services companies like Schlumberger.
It means sticking with consumer staples companies that have weathered many storms in over a century in business, like Johnson & Johnson and Clorox.
It means owning gold and silver. Neither has been in rally mode, although they’re up a decent amount. But if this market goes risk off, it’s going to happen fast and you’ll be buying in during a big rally. It’s easier to get in now.
Tech may weather the storm the best since most big U.S. tech firms don’t have a huge amount of business in China. Google, Microsoft and Amazon are solid picks.
And if you really want the ultimate risk off trade, buy ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA: UVXY), which doubles the movement in the short-term VIX futures index.
— GS Early