Santoli: Stock market may be too calm ahead of Trump’s disruption of DC

Published Mon, Jan 16 20176:07 PM ESTUpdated Mon, Jan 16 20176:28 PM EST

For the past month, the stock market has been hard to impress, but also tough to rattle. The bright-side crowd is calling this "resilient," while the skeptics prefer "oblivious." So which is it? Probably a bit of both, as you might imagine. Equities have walked a narrow lateral track since mid-December. On Dec. 13, exactly five weeks after Election Day, the S & P 500 closed at 2271. On Friday, it finished at 2274. During that time, the index has been contained in about a 2 percent range from high to low. And, of course, its senior colleague, the Dow Jones Industrial Average , has hovered just below the round-number, bragging-rights level of 20,000. This, in many respects, is the way our passively owned, quantitatively steered market trades for weeks-long stretches now. After a sharp rally, all the eyeballs and algorithms deem the indexes a bit overbought, but figure any dip would be a good place to buy. So the dip is deferred? Something quite similar happened from July into September of last year, after the neck-snapping post-Brexit rally got the market to a new high and then the indexes sat pretty still for more than six weeks. Then, as now, traders and other worriers pointed to the "low" level of the CBOE S & P 500 Volatility Index , or VIX. Then, as now, the VIX had spent a good deal of time beneath the 12 level, near the bottom end of its long-term range. One difference today, though, is that the VIX has been so docile as a polarizing, rule-breaking president prepares to assume office and seems bent on upending decades of normal governing procedures and recasting the tax and health care systems, while questioning some core tenets of postwar Western trade and security relationships. That's why charts like this one are making the rounds, showing a quiescent VIX (the global version) conspicuously unmoved by a spike in a measure of economic-policy flux across the world: If this were the core relationship driving markets and the VIX's "job" was mainly to capture the variation in possible economic policy outcomes, then we should be in for a significant volatility storm, barring an immediate outbreak of policy certainty. Yet the VIX is a statistical measure of the implied volatility priced into S & P 500 index options for the next few weeks – traders' best collective guess of how jumpy the index will be in the short term. One major input in this assessment is just how volatile the market has been lately. On this score, the index's actual, displayed volatility has been running near 8 (on the same scale where VIX is now 11.2). That means VIX, while low, is merely understandably low given the market backdrop. As for other inputs to expected stock volatility, recession risk and credit stress have virtually evaporated. Here's Ned Davis Research's implied recession-risk model: Source: Ned Davis Research We also have seen a shift in market character away from a macro, central-bank preoccupation toward one that sifts among individual stocks and sectors to select relative winners and losers. This chart from Bank of America Merrill Lynch shows stocks moving with increasing independence of one another. This also serves to muffle index-level volatility, as many stocks have offsetting moves. Even as the S & P 500 has hovered near a record high, more than a third of its component stocks are at least 10 percent below their 52-week peak. So all this helps explain and justify why the market has been so calm. But what does it say about whether it will stay that way – or whether it's indeed due to sustain some pain before the chance for much more gain? Volatility is a pendulum, but one that swings in an erratic cycle. So, yes, periods of unusual calm are eventually followed by stretches of hazardous market weather. There's a case to be made that a willfully unpredictable executive and a noisy policy slate - with unrealistic hopes for corporate nirvana meeting the typical kinks and leakage of the legislative process – could provide the cue the market needs to reset prices and expectations a bit lower. Joe Fahmy of Zor Capital, who's been correctly bullish and called the mid-year 2016 rebound the start of a new bull phase, is tactically defensive as the inauguration nears. In a weekend blog post, Fahmy wrote: "I currently have a larger than normal cash position for my clients and I even added some short positions last week to hedge our long positions. Again, I am not calling for a major correction, just a potential 'sell the news' event after the Inauguration. If this happens, it might feel worse than it really is because the recent low volatility has lulled people to sleep." The inauguration also arrives as measures of investor, consumer and business confidence have surged, raising the potential for disappointment in the short term. And while the corporate-earnings path looks encouraging in the coming quarters, stocks are on the expensive side, so investors will be pretty demanding about results and management outlooks. Any shakeout in stocks - perhaps related to disillusion with the policy prospects or a rupture in global trade relationships under a President Trump – would probably be limited by the fact that the rally since the fall has not been solely or even mainly about policy changes to come. The global deflation/recession scare ended over the summer, global manufacturing indicators and industrial commodity prices have reawakened, credit markets are sturdy. In fact, global developed equity markets have been outperforming the U.S. in recent weeks. Returning to the August experience as a guide, those six weeks of sleepy sideways action ended in early September with what became about a 4 percent air pocket. The catalyst? Boston Federal Reserve President Eric Rosengren hinted the Fed truly was set on lifting interest rates. And the market did not yet have confidence that the economy was reaccelerating. Such concerns seem almost quaint and hardly relevant now. Yet sometimes, when even a resilient market is poised to refocus on risk over reward, almost any excuse will do.

Donald Trump

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For the past month, the stock market has been hard to impress, but also tough to rattle. The bright-side crowd is calling this "resilient," while the skeptics prefer "oblivious."

So which is it?

Probably a bit of both, as you might imagine.

Equities have walked a narrow lateral track since mid-December. On Dec. 13, exactly five weeks after Election Day, the closed at 2271. On Friday, it finished at 2274. During that time, the index has been contained in about a 2 percent range from high to low. And, of course, its senior colleague, the Dow Jones Industrial Average, has hovered just below the round-number, bragging-rights level of 20,000.

This, in many respects, is the way our passively owned, quantitatively steered market trades for weeks-long stretches now. After a sharp rally, all the eyeballs and algorithms deem the indexes a bit overbought, but figure any dip would be a good place to buy. So the dip is deferred?

Something quite similar happened from July into September of last year, after the neck-snapping post-Brexit rally got the market to a new high and then the indexes sat pretty still for more than six weeks.

Then, as now, traders and other worriers pointed to the "low" level of the CBOE S&P 500 Volatility Index, or VIX. Then, as now, the VIX had spent a good deal of time beneath the 12 level, near the bottom end of its long-term range.

One difference today, though, is that the VIX has been so docile as a polarizing, rule-breaking president prepares to assume office and seems bent on upending decades of normal governing procedures and recasting the tax and health care systems, while questioning some core tenets of postwar Western trade and security relationships.

That's why charts like this one are making the rounds, showing a quiescent VIX (the global version) conspicuously unmoved by a spike in a measure of economic-policy flux across the world: