Calm Markets? Maybe Not For Long

Stock market volatility has been muted for much of this year. In March, amid the failures of Silicon Valley Bank and Signature Bank, the Cboe Volatility Index, or VIX, spiked above 20, the demarcation line for high volatility. Now, it’s back to just under 16, in tune with April’s calm market.

We may be in for a resurgent VIX, however, Goldman Sachs warns. That means trades are more difficult and potentially more expensive for investors. Worse, the higher volatility could bring another nasty market tumble, in Goldman’s view.

Right now, though, investment terrain look just ducky. The bear market bottomed out last October and since then the S&P 500 has largely trended upward, with the S&P 500 climbing about 17%. This falls short of the bull-market indicator of a 20% rise, dating from the bear’s low point.

Where the market goes from here depends mostly on the economy, and many savants continue to predict an imminent recession (as they have since at least the outset of 2022). As investment bank Evercore ISI commented, “no bear market has ever ended without a cathartic spike.” Plus, no bear run since 1950 has ended before a recession began.

True, patterns are made to be broken, and the financial world’s path of late—navigating a worldwide pandemic, resurgent inflation, dramatically higher interest rates and a land war in Europe—has been fraught. Certainly, any number of big events could rattle things even further. Likely candidate: a default on U.S. Treasury bonds due to partisan gridlock over raising the federal deficit ceiling.

A still “perky economy” has kept the VIX on the low side, according to a Goldman Sachs analysis. Christian Mueller-Glissmann, head of asset allocation research within portfolio strategy at Goldman, sees the future as a slow-motion pratfall. He predicts that the U.S. economy will expand 1.6% this year, which is below its historical trend. And from that point, it will keep dropping.

This eventual slowdown has investors quietly preparing for more of market churn, Mueller-Glissmann argues. He notes that the VIX “is upward sloping, a sign investors expect volatility to increase in the future.”

Beneath the surface, he says, the cost of puts (bets on stocks dipping) has outpaced the price of calls (wagers on the opposite). “The market is starting to be more worried about downside risk than upside risk,” Mueller-Glissmann says in the Goldman report. “Convictions levels are low, but people are feeling bearish.”

The scenario, Evercore warns, may be a reprise of what happened a decade ago, also involving a debt-ceiling crisis. The 2011 standoff between congressional Republicans and the Obama Administration resulted in a VIX jump, a credit rating downgrade on Treasury paper from Standard & Poor’s and a 19% decline in the S&P 500.

If that happens, today’s calm climate will look like an idyllic spell.