Discounting “Chaos”

Among the many things people, myself included, got wrong concerning a Trump election is that he would bring an increase in volatility. Some tweet induced momentary blips in a couple of specific companies aside, it simply has not been the case; the VIX has slumped to 10.52, its lowest close since early 2007.

So of course, this weekend’s events surrounding the executive order regarding immigration has the doom and gloomers creeping out of their caves crying, “the market ran too far and now here comes the chaos and we’re going to crash.” Let’s not overreact, but it is prudent to be aware risks do exist.

Certainly volatility is low, but low volatility typically accompanies bull markets and so far nothing suggests the factors fueling the recent rally. Most money flows from underinvested funds and very positive technical pictures are in danger of reversing. Note, volatility can remain at subdued levels for extended periods. It was basically below 15 from 2004 until 2007.

So one little blip down in SPY and a pop up in VIX doesn’t mean game over for the bull market.

That said, while we are far from “chaos”, there is has been an uptick in uncertainty and the market has already pulled forward the assumption many of the pro-business and economic policies will come to pass, which has been priced into many stocks. The market does not like uncertainty. My quick takeaways are the potential negatives this weekend hints towards.

1) Company specific knee-jerk headline risk. The type we’ve seen from tweets that mostly get resolved quickly may now be spreading to larger policy issues. On Friday retailers got smashed as the possibility of a border tax increase. This morning airlines and hotels will probably come under pressure. These probably represent buying opportunities, if not the day of the news, then shortly thereafter.

2) Policy implementation risk. Is President Trump using up political capital which will prevent him from getting the important tax reform and infrastructure spending passed? These are the policies on which the market have already pulled forward and if they become suspect in the next few months that would be bad. This may be the biggest intermediate term market risk.

3) International trade and diplomacy risk. I think it’s probably a good thing to re-negotiate trade pacts and take a more bilateral approach. But it also multiplies the possibility for things going wrong or escalating into outright hostilities. Mexico has already pushed back (I don’t think people realize just how important Mexican imports are to all parts of U.S. economy) and this may embolden China to draw a harder line. Things will mostly work out but Trumps style is to break a few eggs on the way to making an omelet.

Given the low level of implied volatility it is probably prudent to purchase some exposure for what could be a bumpy ride over the next few weeks as policy initiatives get debated and implemented.

For a larger sense of perspective for how there is always “chaos” and uncertainty just around the corner I think this piece from Josh Brown (AKA the Reformed Broker) has an amazing look at the history of immigration in the U.S., ugly political cartoons and all. Please take look, it gives a great sense of perspective.

It is shameful, filled with fear mongering, racism and misguided policy, which may have seemed to serve self-interest but ultimately was negative for the country, to say nothing of the pain it caused individuals.

The good part? We manage to always move towards improvement and aspire to do the right thing. And this country has always been, and remains to be, despite whatever nonsense was going on, the desired destination for the best and brightest around the world.

— Steve Smith

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About the Author: Steve Smith