NEW YORK (CNN/Money) -
More investors think U.S. stock markets are in for smooth sailing than at any time in nearly eight years, according to a key gauge of volatility expectations. When things are this quiet, is it time to start worrying, especially with Fed Chairman Alan Greenspan promising interest rates will rise?
As of Friday, the Chicago Board Options Exchange's Volatility Index (VIX) was holding steady well below 15, near its lowest level since late 1996. It was the third time this year the index dropped below that level.
The VIX collects prices in the options market to see how choppy investors think the water's going to be in the near future -- the higher the prices, the greater the expected churn. Some market analysts, always on the lookout for the contrarian indicator, see too much calm and confidence as a sign that things are about to get interesting.
"Are we going to break up or down? It's hard to say at this point," said Carlos Asilis, portfolio manager at Vega Asset Management. "What is becoming clear is that buying volatility may not be a bad thing."
In the late 1990s, when stocks got really bubbly, the VIX mostly stayed well above 20, reflecting the churn in all those dicey dot.com stocks. Whenever it dropped below 20, market analysts got nervous.
In early 1998, the VIX slipped below 20, signaling calm waters ahead. A few months, one Asian currency crisis, one Russian crisis, one stock run-up and one brutal stock sell-off later, the VIX was proven wrong -- to say the least.
In mid-1999, the VIX fell below 20 again. The only thing that followed was the bursting of the Internet stock bubble.
So should investors be worried that the VIX is so low again? Not necessarily. For one thing, the economy's strong, earnings are great and Greenspan did promise to take it easy on interest rates -- maybe all this happy news means the market is justifiably calm.
For another thing, the VIX has been below 20 for a fairly long time, since November of last year, without any subsequent disasters. As CNN/Money wrote earlier this year, a surge in convertible bond issuance could have something to do with keeping the VIX at a sustainably low level.
Before the dot.com bubble started swelling up, the VIX spent years below 15 -- there's a chance we're simply moving into a similar era of calm, according to Bernadette Murphy, chief market analyst at Kimelman and Baird.
"This is what a lot of us who have always looked at the VIX have a reservation about -- it's not the late 1990s any more," Murphy said.
The only problem is, there are several other indicators -- including a scant amount of investors placing "short" bets, in which they make money if stock prices fall -- that optimism has gone a bit too far, according to Paul Nolte, director of investments and technical market analyst with Hinsdale Associates in Hinsdale, Ill.
"Right now sentiment is all loaded on one side of the market," Nolte said. "It gives you the idea we're running late in the game -- we may be in the process of putting in a short-term top in the market."
Oddly enough, even with everything coming up roses, the S&P 500 couldn't cross its recent resistance level of 1,150 this week. If all the news continues to be good next week, then it finally could break out and move higher.
The week will bring another slew of earnings reports, which are expected to continue the quarter's trend of surprising strength -- earnings for companies in the S&P could post gains of some 25 percent over a year ago, according to earnings tracker First Call.
Key earnings reports this week include CNN/Money parent company Time Warner (TWX: Research, Estimates), DuPont (DD: Research, Estimates), McDonald's (MCD: Research, Estimates), Anheuser-Busch (BUD: Research, Estimates), Monster (MNST: Research, Estimates), BP (BP: Research, Estimates) and Exxon Mobil (XOM: Research, Estimates). [For a detailed look at these and other key earnings expected next week, click here.]
Economic reports due this week include measures of home sales, consumer spending and confidence and the first reading of gross domestic product (GDP) growth in the first quarter. All are expected to show continuing improvement in the economy, which could help boost the S&P through its 1,150 ceiling.
But Asilis of Vega Asset Management suggested that, no matter what the S&P does in the short term, in the long run it will not be able to ignore the impact of higher interest rates -- which are coming, as Greenspan hinted this week.
Contrary to what several bulls told the Wall Street Journal on Friday, Asilis believes financials, which make up a big chunk of the S&P 500, will suffer in a higher-rate environment, keeping the S&P's gains muted.
"Even though the S&P may move sharply up or down in the short term," Asilis said, "my take is that, over the balance of the next few months, it will be close to where it's at now -- between 1,080 to 1,175."
Key events in the week ahead:
- Monday morning, the Commerce Department reports on sales of new homes in March. Economists, on average, think sales sped up a bit to an annual rate of 1.168 million units, compared with 1.163 million in February, according to Briefing.com.
- Tuesday morning brings another reading of the housing market in March, when the National Association of Realtors reports on the pace of previously owned homes -- the biggest chunk of the market, by far. Economists, on average, expect an acceleration there, too, to a 6.2-million-unit annual rate, compared with 6.12 million in February.
- Also on Tuesday morning, the Conference Board releases the results of its monthly survey of consumer confidence, the biggest such measure around. After several poor readings, an improvement might confirm the sky is the limit for the economy. A further deterioration could mean the economy's improvement isn't registering on the home front, where it really matters. Economists, on average, are splitting the difference -- they expect the measure to be flat at 88.3.
- Thursday morning, the Commerce Department releases its first reading of GDP growth in the first quarter. Economists, on average, are expecting a 5-percent annual growth rate, compared with 4.1 percent in the fourth quarter of 2003.
- The Labor Department's measure of new claims for unemployment benefits during the week of April 17 is also due Thursday morning. Economists, on average, expect claims to drop sharply to 340,000, compared with 353,000 in the week of April 10, according to a Reuters poll.
- Friday morning will bring the Commerce Department's measures of consumer income and spending during March -- critical, since consumer spending makes up more than two-thirds of total GDP -- while the University of Michigan will release its revised consumer sentiment index for April and purchasing managers will report on business activity in the Chicago region during April. Economists, on average, expect all of these measures to show improvement.
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