With movie awards season around the corner, some entertainment pundits may use the term “category fraud” to describe races in…
Historically, two indices have moved hand-in-hand: the Global Economic Policy Uncertainty Index and the VIX Index. The former is a measurement of uncertainty surrounding economic and political policy on a global scale, while the latter is a gauge of the volatility level for the S&P 500 index. The relationship between the two should not be surprising: as uncertainty increases, equity volatility rises. What is surprising is the recent divergence of the two. While global economic policy uncertainty surged to recent highs, market volatility is close to 20-year lows. Since the late 1990s, the 3-month rolling correlation between these indices has hovered around 60%; a divergence of the two to this extreme has not been seen in recent history. So what has caused this disparity?
One answer could be the election of Trump, which could explain the directionality of both indices. The contradictory nature of White House statements versus direct quotes from Trump himself oftentimes leaves the public unsure of what to expect next, as it relates to policy direction. Meanwhile, markets have climbed from the “Trump Effect,” which reflects optimism about the successful implementation of new business-friendly policies. An alternative explanation could simply be that company earnings have been sufficiently strong to support current valuation levels. Though there is global policy uncertainty domestically and internationally — notably due to the populist movement in Europe — strong earnings have more than offset this policy uncertainty and thus driven markets higher and perceived risk lower.
Can both sentiments concurrently be correct? This trend certainly hasn’t been the case in recent years, however, the divergence has continued since Trump’s inauguration. Only time will tell if one of these indicators is truly victorious.
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