Be afraid. Be very afraid.
A major predictor of stock market volatility moved to a five-month high yesterday amid growing fears that Washington’s gridlock will push the nation off the fiscal cliff.
The Chicago Board Options Exchange’s SPX Volatility Index — popularly known as the VIX “fear index” — jumped 6.27 percent to 20.70. It was the first move above 20 since July. In Main Street parlance, that means investors, mostly hedge funds, are betting on a roller-coaster ride in stocks.
The jump comes as President Obama and Congressional leaders butt heads over how to stop a painful mix of tax hikes and spending cuts from automatically kicking in on Jan. 1.
Economists warn, that without a deal, the economy could plunge into another recession — prompting a major market sell-off.
“If we don’t get an agreement by year-end, you will see a sharp sell-off early next year,” said Manish Bangard, US equity strategist with UBS.
President Obama summoned congressional leaders for last-ditch talks. Elsewhere, House speaker John Boehner’s (R-Ohio) called the House to session tomorrow in hopes of hammering out an 11th-hour deal.
Until now, Wall Street has been surprisingly complacent about the potential nose-dive off the cliff. The S&P 500 index is set to close the year up 12 percent.
The VIX, meanwhile, is down 12 percent this year, indicating that volatility and fear have been relatively low.
Wall Streeters have long predicted that Washington will step in to avoid economic calamity. Even now, many market pros predict that legislators will let the nation “bungee jump” off the cliff.
One way to do this is by agreeing to a short-term extension of the current tax cuts while they work on a longer-term deal. Lawmakers could also craft a smaller bill to avoid the worst of the economic hit.
But even a bungee jump off the cliff could send stocks lower, experts said.
“If we don’t fully go off the cliff then the impact on markets is more ambiguous — ambiguous to slightly negative,” said Joe LaVorgna, an economist with Deutsche Bank.
A longer-term resolution is the only thing that will send stocks higher because it will equip investors with the certainty they so desperately crave, experts said.
“The problem is it’s very hard for many investors to take an aggressive position one way or another,” said David Kelly, chief market strategist for JPMorgan. ”When this cloud is lifted I expect stocks will move higher.”
Few on Wall Street see a comprehensive solution before year end, meaning stocks could start off on another awful roller-coaster ride next year.
“We’re running out of time,” said UBS’s Bangard, adding that for lawmakers “the odds are not leaning in their favor.”