The hottest Trump trade of them all just set a new record

Buy volatility in this market: BoAML
Buy volatility in this market: BoAML

In Washington, volatility is running at highs not seen in years. On Wall Street, volatility is running at lows not seen — ever.

The stock market is on a 48-day run of not having moving up or down more than 1 percent in any single session, something that rarely happens and is all the more remarkable considering the political commotion since President Donald Trump took office nearly four weeks ago. The level of realized volatility is the lowest in records going back to 1962.

In terms of intraday price movements, the has never started a year with a tighter range than it has seen since 2017 began, according to analysts at Sandler O'Neill. Stocks have been on a gradual but steady move higher, with the index gaining just shy of 10 percent since the controversial Republican took over.

Such market complacency normally would be a matter of concern.

A market that shows little or no reaction to outside noise gets increasingly susceptible to a downturn should something meaningfully jolting come along.

But in this case, the mellow mood on Wall Street appears to be a reflection that the market and the economy have hit a sweet spot that has divorced itself from the political chaos, and the lack of volatility is justified.

Rather than serve as a contrarian signal that a reckoning is on the horizon, the low volatility readings are "a false warning," said Art Hogan, chief market strategist at Wunderlich Securities.

"The market seems to want to focus on what could be the positives," he said. "If we get a pro-growth agenda and move forward, the market is (focusing on) that a whole lot more than the market's worried about a constitutional crisis in the Mike Flynn fiasco."

The short-volatility Trump trade

Flynn was Trump's national security advisor who resigned Monday following disclosures that he had conferred with Russian operatives, despite denying that he did so. While a blow like that to the new president might have knocked the market for a loop, the S&P 500 is up more than 1.4 percent this week.

Investors don't anticipate much trouble ahead, either.

The CBOE Volatility Index, a gauge of options traders' expectation for the S&P's fluctuations over the next 30 days, is well below its historical average.

Indeed, betting against volatility has been the best Trump trade of them all.

The VelocityShares Daily Inverse VIX Short-Term exchange-traded note bets against the index over one- and two-month periods. The wager has delivered a 78.6 percent gain over the past three months and is up more than 318 percent during the past 12 months.

Chad Slattery | Getty Images

The VIX has tumbled 12 percent in 2017, close to a record, and is down nearly 50 percent over the past 12 months, according to Sandler O'Neill. The firm's measure of actual volatility against the VIX's measure of implied volatility is at a record low as well.

The VIX's long-term average is just under 20, but it has averaged around 15.6 for the past five years and just above 12 since Trump won the presidency in November, according to Convergex data.

Traditionally, the index rises when the market falls. However, that's not always the case. Wednesday's gain saw a massive VIX spike even as the market staked out yet another new high.

'More uncertainty' coming?

Nick Colas, chief market strategist at brokerage Convergex, believes a "volatility reset" may be the case in the days ahead as relatively constant numbers tied to economic growth begin moving in surprising ways.

"Since both equity and fixed income markets are now discounting faster economic and corporate earnings growth, the predictability of the last five years should give way to more uncertainty about those key drivers of stock prices," Colas said in his morning note Thursday. "And with that, the VIX should rise from its current torpor."

Rising corporate earnings following a profits recession and expectations for higher interest rates will be two key drivers in market volatility, even if they're not rally-killers.

"The upshot of all this is simple: the VIX can (and should) rise in the current macro environment, even if equities continue to rise," Colas said. "Earnings will become less predictable, albeit in a 'good way' because we will be unsure if they can grow at 8 percent or 12 percent. Or maybe 15 percent ... And interest rates should similarly pull away from their historical roots."

So while the market may keep drifting up, expecting the same level of market complacency could be a mistake.

"On one hand, you've got to respect the momentum in the market," said Todd Salamone, senior vice president at Schaeffer's Investment Research. "There's something that lurks that makes me think that this could be something contrarian. If all of a sudden the VIX pops ... I cannot say I'd be overly surprised."