Equity prices have been stagnate for several weeks lingering near all-time high levels. This sets the stage for any slight move higher in stock prices to bring about a “new all-time high”. So, in other words, the latest all-time high that is written into the headlines of the business news may only be a point or two higher than the previous day’s closing price. These headlines may draw attention to the news organizations but gives investors little sense of what has really been happening in the market.
What is a bit more important to us here at KIG than the “all-time high” rhetoric is the very low volatility of stocks lately. The measure of stock market volatility (Chicago Board Options Exchange Volatility Index), commonly referred to as the “VIX”, hit its lowest level since 1993. This catches our attention as it is an indicator of complacency in the market. Persistent complacency can lead to dramatic market turns. The question is whether the turn in the market will be higher or lower from here.
We have been consistent in our very bullish view of the future for stock prices but, of late, we are concerned about the prospect of a downturn. The low “VIX” that has persisted through a news cycle that included tensions in North Korea, the French election of a president, political wrangling here in the U.S., along with several “below-the-fold” news items, makes us wonder if complacency is reaching a dangerous level.
I have said many times recently that the current market environment is as difficult to navigate as any since the Financial Crisis. The market could very easily shake off the low volatility and move higher from here. It could also move with some gusto toward lower prices. It is easy to find reasons why the market SHOULD NOT go higher. This appeals to our contrarian spirit and suggests that stocks might just take off higher from here. Our pragmatic spirit pushes us to be cautious, however. At this point, we believe a move in one direction over the other is imminent but the probability seems to be the same for both to occur.
This tug-of-war has kept us sitting on our hands instead of making significant investment decisions. It has been my experience that making buy/sell decisions in a sideways market tends to lead to regrettable decisions more than profitable ones.
A topic we will discuss more in the upcoming letter to clients is our shift away from sector-based decisions in favor of one based more on market capitalization (size). The upcoming volatility we expect will give us the opportunity to make this transition in earnest. It is a change that is tied to our view that we have transitioned to a new 17-year cycle for the market. The new 17-year cycle we just entered will see the largest companies outperform all others, we believe.
So, we are paying close attention to the market despite our lack of buy/sell decisions in our managed accounts. We expect a move higher or lower in stocks to take shape very soon and for the direction of the move to persist through the summer. The third quarter looms ahead regardless of how this quarter plays out. It is frequently a difficult quarter for stocks and we believe this year will be no exception.
Kessler Investment Group, LLC