The S&P 500 Index climbed 15 points, or 0.77%, to close at a record high of 1956.98. The 10-year Treasury Note yield fell 42 basis points to settle at 2.61%. The VIX dropped 12.02% to close at 10.61; a level not seen since February of 2007.
There are several factors to consider here. First, the Volatility Index (VIX) is a measure of implied volatility for the S&P 500 Index (SPX). The VIX is a real-time measure of the amount of premium investors are willing to pay for options on the SPX; the more premium, the higher the VIX. While the premium is calculated on both Put and Call Options, the VIX is sometimes viewed as the “fear gauge” because of the premium investors are willing to pay for “Put Protection”. However, this can be misleading and misinterprets the larger implication: the VIX is a measure of market participants’ expectation of the future range of the SPX. That is, as of the close today, the VIX suggests the 12-month return of the SPX will be +/- 10.6%. Of course, this is an expectation and prone to error. As noted before, this is the smallest range in more than 7 years. It also suggests there may be limited upside remaining in this bull market.
Second, investors have overcome their 2008/2009 financial market “shell shock”. The biggest risk to an investor’s portfolio is always behavioral risk. Looking back at the past 5 years, the biggest risk to an investor’s portfolio was that of being too cautious and reducing (or eliminating) equity exposure from her portfolio. That was a behavioral response to losses incurred in 2008 and/or volatility experienced in 2009. The same statement can be made for the period following 2001 and the exact opposite statement can be made for the periods just prior to 2008 and 2001. It ebbs and flows in cycles. It is human nature. And now that investors are once again more focused on the upside, rather than the downside, the cycle is likely to change once more.
Those comments were not meant to suggest a coming correction. In fact, I’ve blogged on numerous occasions about our plateauing equity market thesis. And I believe the economic data and equity market price movement continue to point to that. For instance, earlier in the year, the SPX dropped 5.975% from its 2013 close; currently, the index is 5.875% above its 2013 close. I expect any additional moves to the upside to be a grind with the SPX ultimately following a flat-to-slightly-positive trajectory for 2014.
Today, the FOMC announced that they will taper an additional $10 billion from their monthly bond purchase operation, also known as QE3, reducing the total monthly purchases going forward to $35 billion. They also released the Committee’s projections for 2014 GDP. Below is a chart of their estimates over time. (The bars represent their “central tendencies” while the lines represent the high and low projections for that period).
It is rare for economists to underestimate GDP (among other things). Now that the final revision to 2014-Q1 GDP will likely decline by more than one percent, full year estimates need to be reduced. As I’ve stated in a previous post, I highly suspect that 2014-Q2 GDP will fall short of the 2.8% – 3.0% estimates currently published.