The must-read implications of low volatility in the US

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As I write in my new weekly commentary, recently U.S. stocks reached new highs and volatility hit its lowest level since before the recession, as an accommodative Federal Reserve (the Fed) and a steady stream of mergers and acquisitions trumped escalating violence in Iraq. For the time being, the fighting in Iraq doesn’t appear to be threating the major oil fields in southern Iraq, which are responsible for most of the country’s oil exports, giving investors a reason to shrug off headlines out of the region.

Based on price-to-book metrics, U.S. equities are now trading at their most expensive level since late 2007, while equity market volatility as measured by the VIX is at its lowest level since early 2007, as the chart below shows.

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While stocks still appear more attractive than bonds and cash, investors should be cognizant that U.S. equities are no longer cheap and, as the low volatility environment indicates, discounting little in the way of bad news. This means that U.S. equities may be particularly vulnerable to an exogenous shock, such as a deterioration of events in Iraq.

Market Realist – The VIX index is an indication of the expected 30-day volatility. Although the VIX is also referred to as “the fear gauge” or a measure of risk, it includes volatility on the upside as well. As you can note from the graph above, the VIX (VXX) had been low for a long time until a recent uptick.

But U.S. equity (SPY)(IVV) valuations are looking stretched, to say the least, relative to some of the other developed economies, such as Japan (EWJ) and the Eurozone (EZU). Find out more in the next part of this series.

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