Is Volatility Playing Hide-and-Seek?

Markets continue to grind higher, but beneath the surface, volatility remains surprisingly subdued. Scott Bauer joins Jeff Praissman to discuss bond yields, small-cap struggles, oil swings, sticky inflation, and whether the VIX is about to reemerge from hiding.

Summary – IBKR Podcasts Ep. 297

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jeff Praissman 

Hi everyone. This is Jeff Praissman with Interactive Brokers Podcast. It’s my pleasure to welcome back for our midweek podcast, Scott Bauer from Prosper Trading Academy. Hey, Scott, how are you? 

Scott Bauer 

Jeff. I am just fantastic. How are you? 

Jeff Praissman 

I’m doing great, and I love having you come in here for these Wednesday sessions where we just spend a few minutes talking about the past week in the market and then what’s up ahead. I want to kick it off with treasury yields and they’ve been climbing steadily over the past week, with the 10 week touching, I think around 4.3%. How do you interpret this bond market behavior against the backdrop of the strong equity performance we’ve been seeing as well? 

Scott Bauer 

Sure, especially after the Fed reduced rates a quarter point last week, that really didn’t sink into the longer end of the yield, the 10, 20, 30 year. And I think what that tells us is there’s a lot of, let’s call it consternation. There’s a lot of concern that inflation is not under control or that central banks, not just our central bank, but central banks around the world maybe are in a gregarious place here. And you know what that means is by the longer end of the curve not coming down, it means that investors are looking for higher and higher yield to be able to buy into treasury funds or even other central banks around the world. 

So there is that concern there. We’ll see what happens. If the Fed continues with the rate decreases coming up next month and then maybe another cut in December, we’ll see if that does follow. 

Jeff Praissman 

Yeah. And switching gears a little bit, everyone’s always talking about the Mag Seven and large caps and all household names, but I kinda want to focus on small caps. ‘Cause no one really mentions them and they, once again, significantly underperformed large caps again this past week. Is this divergence a warning sign for the broader market? Or is it just simply a reflection of that ongoing concentration of these mega cap tech? 

Scott Bauer 

Yeah, I think you have a couple things working here. The small caps have really lagged for a long time and they made an incredible run over the last month or so to really gain some ground. But then, after that Fed cut, again with not seeing the bond market really reflect that, hurt the small caps because these small cap stocks are the ones that need to go out and they need to borrow more. 

They need to really lean on the bond market and interest rates, and not seeing those rates that they would need to lock in to borrow money for R&D and for expansion—I think that’s why we’re seeing the small caps get hit again. 

Jeff Praissman 

Got it. And continually to pivot away from these tech stocks. ‘Cause oil—oil historically has been very important. And I feel like the last couple years, it hasn’t been as much of a headline grabber with all the tech action we’re seeing. 

The oil price has been particularly volatile lately. With WTI crude it was experiencing some significant daily swings. What factors are driving this energy market turbulence and what might it signal about global economy expectations? 

Scott Bauer 

I think we have both sides of the coin here. Fundamentally, supply still outweighs demand. When you look at basic economics, we should see prices coming down, which we have. However, there’s a lot of volatility in the oil markets because now all of a sudden we saw inventories decline a little bit and maybe the geopolitical risk is ratcheting up a little bit, right? 

The Ukraine–Russia situation is probably a bit more volatile at this point. In fact, we saw oil prices actually tick up after Ukraine’s military said that it struck two oil pumping stations in Russia. So I think we’re trying to balance that. Globally, I believe there’s still more supply than demand. 

But you know that whenever there’s a geopolitical event or the risk of that, boy, that typically will hit the oil market pretty quickly. 

Jeff Praissman 

Yeah, no, absolutely. And now I want to repeat to the next five days ahead. So this Friday we got the personal consumption expenditure inflation report, or the PCE, coming out. What impact could this Fed-preferred inflation gauge have on market expectations for further cuts in equity valuations? 

Scott Bauer 

The Fed has said, and we can all see through the data, that inflation has been sticky, right? It’s not coming down, it’s not necessarily progressing much higher. So PCE is gonna be a real close one to watch here. The expectations are that we are going to see PCE prices ticking up slightly month over month. 

So if we do see that, I think the market will take that in stride as long as it is within kind of that threshold the market is expecting. And I think it’s about 0.3% month over month. And then year over year it’s supposed to remain flat at 2.9%. Now we know the Fed wants to see this down towards 2%, so it is sticky. But I think that as long as we don’t see a three handle on that year-over-year inflation, the market should take it in stride. 

Jeff Praissman 

Got it. And I want to wrap it up with something I know that’s near and dear to your heart—the VIX. And usually here it looks like you’re in your home office, but a lot of times you’re right on the floor, right in front of that pit. And it’s remained surprisingly subdued despite all the geopolitical tensions and economic uncertainties we’re facing right now. 

Do you anticipate volatility picking up in the coming days and, if so, what possible catalyst could trigger a shift considering everything we’re going through right now? 

Scott Bauer 

I definitely do. I think it is subdued. The market trend has been grinding higher, so maybe that’s playing into a little bit about the VIX being subdued. But when you look at a VIX of 16, which is pretty much where we are right now, that really correlates to a 1% daily move in the S&Ps, which we’re right in that ballpark. 

But with all of the macro headwinds—whether it be the Fed, interest rates, inflation, or geopolitical risks—I would anticipate volatility to pick up. In fact, just over the last couple days, Jeff, and even this morning, we’re starting to see some of those big out-of-the-money call buyers in the VIX strikes, like up at the 60s and 70s strikes, start coming back in again. So I would expect vol to pick up. 

Jeff Praissman 

Ah, Scott, this has been great. Always appreciate you coming by. For our listeners, you can find more from Scott at prospertrading.com, as well as on our website. We do a podcast probably about every other week on the markets. And until next time, Scott, thank you for swinging by. 

Scott Bauer 

Thank you so much, Jeff. Always great to be here. 

Jeff Praissman 

Perfect.