As VIX slumbers, investors grow complacent

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Bill Luby at the VIX and More blog has been polling readers weekly on their top fears. In the latest poll, concerns about the U.S. deficit and debt ceiling have become the No. 1 concern, outscoring earnings season and the European debt crisis.

But the way the CBOE Volatility index, or VIX, has been behaving recently, you have to wonder if investors fear anything at all right now.

The VIX – widely seen as a fear gauge, rising when nerves are frayed – had been signalling some unease on the part of investors during negotiations over the U.S. budget in December.

No one was really sure if the bickering among politicians would send the United States over the so-called "fiscal cliff" of automatic tax increases and spending cuts, pushing the economy into recession.

The resolution to that crisis, along with a relatively uneventful U.S. payrolls report on Friday, eased concerns and deflated the VIX in a big way: It fell for four straight days last week, falling a total of 39 per cent. That marked its biggest one-week decline since the index was created in 1990.

The VIX hit a low of 13.83 on Friday, a fraction above its lowest point in the past five years. It was recently spotted on Tuesday at 14.22, which is still exceptionally low. Even December's high point of 22.72 looks relatively subdued next to recent spikes above 40, when investors fretted about the Japanese nuclear crisis, the survival of the euro and the financial crisis of 2008.

The issue is whether the VIX is now so low that it is reflecting investor complacency, and perhaps signalling that markets are due for some turbulence.

Observers are certainly scratching their heads at the recent moves by the index.

Alec Phillips at Goldman Sachs (via Business Insider) compared the VIX's reaction to the "fiscal cliff" negotiations to the 2011 negotiations on the U.S. debt limit – both being examples of political brinkmanship – and found that the VIX seems to be reflecting far less anxiety on the part of investors in the more recent brouhaha. Perhaps the market is getting used to gridlock.

But is the market also sloughing off other concerns? While the euro zone seems to have averted an all-out financial crisis, it remains mired in a debilitating recession. The U.S. economy is making little headway in addressing its high level of unemployment – job gains in December merely kept pace with the rising population – and that's with the help of extraordinary monetary intervention on the part of the Federal Reserve.

And as far as brinkmanship in Washington, we still face more negotiations on the debt ceiling and spending cuts – neither of which is likely to be a joyful experience.

A low VIX also suggests that there are no built-in expectations for ugly surprises, perhaps emanating from the start of the fourth quarter earnings season or the health of China's economy or something that hasn't shown up on radar screens yet.

There is no shortage of things to worry about right now. And the low level of the VIX is at the top of that list.