Certainly for investors here in paradise, the question of “how high is too high” resonates within the cornerstone of the Southwest Florida economy … real estate. Yes, it seems as if the sky is the limit as it pertains to property values. Rational investors can agree that at some point it will level off, leaving some concerns as to how long can it sustain the levels.
It should come as no surprise to any investor with a pulse that the stock markets continue to set temporary record highs with each passing week. This proposition brings several questions to mind, such as “how long can it last?” and perhaps even more compelling, “how high is too high?” Now well into the eighth year of recovery from the last market crash, there seems to be little logic for the run up in prices, especially in light of the fact that the state of the economy has not changed much since pre-presidential election when investors were experiencing somewhat higher levels of doubt and concern. There is no denying the current level of investor complacency.
In fact, this stock market defies all previous modern investing era logic with both the scope and length of the market run. Many feel as if the higher we go, the farther we will fall when the day of reckoning arrives. Only time will tell, thus the critical importance of achieving true diversification before the time to “buckle up” arrives.
Recently, The Fed made headlines as they delivered on their promise to slowly raise interest rates during the fiscal 2017 year. Last week the Fed raised rates another quarter percentage point, making it the third such increase since December. Now these increases should come as no surprise as we matriculate through deeper and deeper unchartered waters in an effort to maintain balance and the ever so elusive “soft landing” as it pertains to interest rates and the state of the markets condition. Our empirical knowledge, knowledge through experience, shows us that rising rates traditionally put downward pressure on both stocks and bonds in the form of the rising costs of conducting business. Yes, traditionally, rate increases at some point, can generate losses in value for both stocks and bonds. The only thing we do not know is “how high is too high?”
Another little known or followed index of the state of the markets is what is referred to as the VIX, or Volatility Index. According to investopedia.com, the VIX, or volatility index, “reflects the market’s expectation of 30 day volatility.” The definition goes further to illustrate the value of the VIX in terms of investor sentiment. Not only is it a “widely used measure of market risk, it is often referred to as the investor fear gauge”, which has endured extraordinarily low levels since 2012. According to the VIX, investors have exhibited a low level of fear or concern as to the state of the markets and their ability to maintain their unprecedented run.
In fact, except for a brief spike in both 2010 and 2012, the index has remained extremely low, which perhaps helps explain one of the many catalysts which push the markets higher over time.
While it is positive for the markets when there is a low level of “investor fear”, certainly at some point when the numbers move in the opposite direction, there may be a strong correlation between the VIX and the stock market’s direction. Extended periods of higher VIX levels could send a sign that the market may be closer to the, arguably long overdue, day of reckoning. The VIX is a classic example of the answer to the question, “how high is too high?”
The good news for investors who have properly diversified with the addition of alternative asset classes is that traditionally, higher volatility can bring greater potential for growth in the arena of managed futures, with their nearly zero correlation to stocks. Yes, as odd as it sounds, greater volatility has, historically, offered an opportunity for managed futures to generate robust returns. Certainly profiting when the stock markets fall allows for the life of a SWAN, Sleep Well An Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.