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ETF Securities says beware the false sense of security

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James Butterfill, head of research and investment strategy at ETF Securities, writes that US equities have started the year in an amazingly tranquil way. He writes that under such calm, the Dow and S&P500 have reached record levels.

Consensus is optimistic, he says, expecting corporate earnings growth of 21 per cent this year, while the VIX is exceptionally low. The VIX, a perceived measure of market risk, highlights that there is little fear in the market at present.

This year it has averaged 11.2, well below its long-term average of 19.6, putting this in context, only 4 per cent of the time is it ever this low. He writes that on the one hand, good corporate earnings, the prospect for corporate tax cuts and expected infrastructure spending could justify such optimism, but on the other hand, it is puzzling that political volatility in both the US and Europe is not being reflected in the VIX.

“However, other indicators do not share such a placid view of the world. For example, government bond yields have remained low, indicating that risk appetite has not normalised. We believe the VIX and corporate tax cut promises are lulling some investors into a false sense of security. Leaving equity markets vulnerable to a sell-off in the event of further interest rate rises and disappointment from the US political administration.”

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