The VIX index - a measure of implied volatility on S&P options which is often regarded as a measure of investors’ fear - is now 15.7 per cent, well below its post-1990 average of 20.3 per cent. Such lack of fear can be a sign of overconfidence and complacency, and for this reason, a low VIX has often led to falling share prices.
But the VIX has been below its long-term average since June, during which time the All-Share index has risen slightly. This suggests that the relationship between risk appetite and return might have changed. This has happened before: the trade-off was better in the bull markets of the mid-90s and mid-00s than in the bear markets of 2000-03 and 2008-09.
Today's low VIX might be a sign not of complacency but rather of a genuine reduction in the dangers facing the global economy. “Uncertainty has diminished,” says Mike Lenhoff at Brewin Dolphin.
One reason for this is that the decisions by the Federal Reserve and ECB to buy more bonds have reduced the risk of a disastrous break-up of the euro and of a prolonged slump in the US. In a speech last week Paul Fisher of the Bank of England’s monetary policy committee attributed the drop in volatility partly to markets believing that central banks “are on permanent standby to deal with tail risks.”
But some believe it is too soon to say for sure that the risk-return trade-off has improved. Not all risks have gone away. Mr Lenhoff notes that while Wall Street is assuming a deal will be reached to stop the US economy falling off the 'fiscal cliff', betting markets are pricing in a 30 per cent chance of a US recession next year. And Guillermo Felice at Barclays Capital adds that, with euro area purchasing managers’ surveys still weak, the risk of continued recession is still strong.
If or when these are dispelled, economists agree that risky assets will rise. But super-loose monetary policy is not sufficient to ensure this. Mr Fisher said: “Central banks cannot solve fundamental problems in the real economy.”
