‘Black swan’ market indicator flashes a warning
A “phase one” US-China trade deal. A resounding election victory for UK Prime Minister Boris Johnson that removes ambiguity on Brexit. In recent days, some of the political fog that’s hung over markets has lifted.
Investors have responded by pouring into riskier assets. Stocks in the United States and Europe have reached fresh records amid the euphoria.
But look at options markets, and a more cautious story emerges. Take the CBOE Skew Index, otherwise known as the “Black Swan” index, since it tracks demand for options that would pay out if the S&P 500 were to see a sharp, unexpected drop.
That index jumped to its highest level in nearly 15 months last week. This signals that investors are looking for protection in case the recent rally goes awry.
“This options-based measure of the cost of ‘disaster insurance’ on US stocks seems to indicate trouble ahead,” Nicholas Colas, co-founder of DataTrek research, said in a recent note to clients.
Colas went on to say that he’s not particularly concerned, however.
“Bottom line: yes, options markets are twitchily expecting the next big crack in US stocks,” he said. “But they have been doing that since 2014, and the S&P has almost doubled during that time.”
Right now, investors generally appear to be in the Colas camp. Demand for safe havens remains muted, with gold prices down more than 3.5% since September.
But with all the excitement heading into the end of the year, talk of smart hedges looks poised to ramp up.
No one knows what the Bank of England will do next
The result of the UK election provided a dose of certainty on Brexit, with Prime Minister Boris Johnson now set to take the country out of the European Union by January 31.
It did not, however, shine a light on what the Bank of England will do next.
The central bank is expected to keep interest rates on hold when it meets Thursday. Looking ahead to next year, though, a lot still needs to play out.
After the United Kingdom leaves the European Union, Johnson will need to negotiate a new relationship with the bloc. The prime minister has promised to rush through a trade deal by the end of 2020 — but that’s a very tight timeframe for complex negotiations.
For businesses, that means the waiting game continues.
“Despite the near-term positive of a ‘no deal’ Brexit being avoided in January, we think uncertainty surrounding the transition period will continue to keep a lid on investment during 2020,” ING senior rates strategist Antoine Bouvet told clients Friday.
If the economic data doesn’t pick up, that could clear the way for the Bank of England to cut interest rates in the middle of 2020. Conversely, if the wage growth and consumer spending start to push up inflation — also a possibility — a rate hike could be in the cards.
The bottom line is that no one knows how the UK economy will respond to Brexit over the next year. Much depends on the status of Johnson’s ongoing talks with the European Union.
Another question mark: We still don’t know who will replace Governor Mark Carney, who’s due to step down at the end of January.