Is The VIX Sending A Warning Signal... Again?

Who believes in the latest equity market rally? After a month-long, near 7% S&P 500 drawdown/decline, the benchmark index has roared back nearly 4.5% in about 6 trading sessions. But what augers concern is the seemingly sanguine signal from the VIX. We’ll get to that in just a minute, but first…

The S&P 500 (SPX) rallied nicely above 2,900 on Monday before running into a brick wall and being abruptly turned back and trimming nearly 50% of its intraday gains. The S&P 500 still finished higher by nearly .50% on the day, which was surpassed by .61% Russell 2000 (RUT) and 1.05% Nasdaq (NDX) gains. The Dow Jones Industrial Average (DJIA) was the laggard on the day with a .30% gain. 

What drove equity prices higher on Monday was the positive sentiment revealed by a “new deal” between the U.S. and Mexico that relieved the threat of tariffs on the country’s exports to the United States. But the deal did leave a sour taste in the mouth of economists, analysts and investors alike. 

“The avoidance of Mexican tariffs is a positive but this wasn’t entirely unexpected and it doesn’t by any means erase the enormous risks inherent in Trump’s trade policies,” Adam Crisafulli, a J.P. Morgan managing director, said in a note on Monday.

Coupled with a positive trade headline that many are skeptical of, seeing how the two parties agreed to little more than efforts to reduce illegal migration and reviewing results over the coming 45 days, were two large merger and acquisition deals. Raytheon and United Technologies agreed to an all-stock merger that would create a combined company with $74 billion in annual sales. Salesforce.com announced its acquisition of big data company Tableau Software on Monday. The $15.3 billion all-stock deal marks the biggest purchase in the company’s history.

While M&A activity has accelerated in the last couple of months, so has economic policy uncertainty. In this past weekend’s Research Report, I outlined that policy uncertainty was at levels not seen since 2016 when the Brexit Vote took place and leading up to the U.S. Presidential election. 

My thoughts and concerns were mirrored in a recent report from LPL Financial. 

“We know policy uncertainty is high, but researchers have actually quantified it by creating a policy uncertainty index. The U.S. version of this index, which counts words in news stories associated with economic and Washington, D.C., policy and tracks them over time, is high—no surprise. The trade-policy-specific version of this index is similarly high and trending upward—no surprise there either. Our friends at Strategas Research Partners tell us that searches for “tariffs” on Bloomberg hit their highest level of President Trump’s presidency last week.”

It’s not just economic policy uncertainty that has weighed on the market and market participants, but the ongoing trade feuds have exacted their toll on the domestic and global economies. The so-called bond vigilantes have driven bond yields to their lows of the calendar year recently and found the 3-month Treasury yield inverting with the 10-year Treasury yield. Additionally, the long end of the Treasury yield has found itself below the Fed Funds Target Rate. Coupled with concerns over a protracted trade war, the market is pricing in a rate cut as early as July and 3 rate cuts in 2019. This is a sharp contrast to the former expectations of rate hikes in 2019.  Here is what Morgan Stanley’s chief investment officer Lisa Shalett had to say about the rate policy “about face” in the last 6 months.

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