Should you fret the record-low VIX reading?

There’s a pretty simple explanation for why the VIX — often cited as the market’s “fear gauge” — is so low.

The measure of implied volatility based on options prices closely tracks the daily movements of the S&P 500, and those gyrations have been rather muted of late.

The index has only moved one per cent or more three times in 2017, compared to an average of 61 per year historically.

“The VIX tends to move with the economic cycle, spiking with recessions and drifting lower during the middle innings,” said Jonathan Golub, chief equity strategist at RBC Capital Markets.

He noted that the current environment of tight credit spreads and limited recessionary risks are consistent with a below-average VIX.

Golub believes recessionary risks will remain muted throughout 2017, and interest rates will edge higher. As a result, he expects the dynamics keeping the VIX very l ow, will remain in place.

But the positive economic backdrop hasn’t quelled concerns that very low levels of volatility means investors are too complacent.

The VIX fell to its lowest level ever of 9.6 on Monday.

Shaun Osborne, chief FX strategist at Scotiabank, sees little evidence to suggest that significant declines in the VIX signal upcoming market stress.

“Rather, t he evidence suggests that ( equity) markets are usually in retreat before volatility surges,” he said.

Osborne l ooked at the past six episodes of very low VIX volatility, and found that the S&P 500 fell significantly just once in the past 10 years after the VIX index troughed (August 2015).

“The VIX index appears to be reactive, rather than predictive, in other words. And extremely low levels have persisted for long periods before rising again on heightened market risks,” the strategist said.

That’s not to say low volatility should be i gnored, particularly given the uncertainty experienced of late due to event risks like the Brexit vote in 2016, and the French election more recently.

There is plenty of reason to think volatility in stocks, bonds and currencies is too low at the moment.

Uncertainties remain, and as Osborne pointed out, low levels of volatility do not correspond with the Fed’s tightening policy, as gradual as it is, and given the fact that other major central banks are closer to the end of the extra- ordinary policy process than the start.

The strategist cited Donald Trump’s most recent scandal involving sharing information with Russia, as a reminder that political risk is front and centre.

Investors should also keep in mind that equity markets typically get more volatile during the middle of the year, and seasonal t r ends s uggest t he VIX moves up significantly in July, August and September.