If you’re craving more volatility in the US stock market, you may be in luck.
The two substantial declines in US stocks this year could become far more frequent in the years ahead, at least if the shape of the US yield curve is anything to go by.
From Bank Of America Merrill Lynch (BAML), the chart below is simply the US VIX — deemed by some to be Wall Street’s fear gauge given it uses options pricing to gauge expected volatility in US stock looking 30 days ahead — overlaid against the spread between US 2 and 10-year government bond yields.
The latter has been advanced by three years to demonstrate the relationship between the two, and inverted.
When the spread, or yield curve, flattens between short and longer-dated government bonds — something that has occurred in recent years — it usually signals a deterioration in expectations for economic activity and inflation in the period ahead.
This “late cycle” indicator not only signals a turning point for the economy, but almost always corresponds with an increase in stock market volatility as the outlook for earnings worsens.
While past performance is not indicative of future returns, if volatility does not lift based on the signals generated by the curve, it will be not quite unprecedented but close.
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