Set up for a rebound in the VIX soon

We have seen a summer relief rally in the US and European stock markets. The rise in prices has been highest on the Nasdaq, where information technology companies have delivered solid Q2 reports compared to expectations.

More encouragingly, the price increase in equity markets has been supported by a simultaneous price increase for HYG (a US high credit risk corporate bond ETF). Buying junk bonds at current low levels is mainly a bet on relatively few anticipated bankruptcies going forward, we believe. Financial crises (most recently the Lehman crash of 2008) tend to be associated with prolonged periods of stock market decline.

Five- and ten-year US Treasury yields are broadly at the same levels as at the beginning of July. This follows a strong US report on Friday 5 August with 528,000 additional jobs created in July and only a 3.5% unemployment rate. Meanwhile, we have seen a downward price trend in commodities recently, which on the contrary should trigger lower interest rates.

The VIX index, which measures market volatility in the US, has come down sharply during July to what looks like a position with a strong possibility of a turn to the upside again. Autumns through October usually bring some weak and turbulent periods for the stock market.

Ukraine is preparing a counter-offensive against the port city of Kherson. The war with Russia cannot expected to be over until the turn of the year at the earliest. In the meantime, Europe (the EU and allied Western countries) should reduce its heavy dependence on Russian gas and oil. Russia, on the other hand, may try to provoke a recession in the EU countries by, for example, restricting access to Russian gas and oil ahead of the upcoming winter. Add to that the risk that Wall Street and European equity analysts may have to lower their corporate earnings forecasts for the second half of 2022, all of which would likely send the VIX index higher from its current low levels.