In the financial world, a sense of calm can often precede a storm. Recently, some of the key market indicators hinted at an uptick in investor nervousness. Now, we find ourselves in the midst of an environment that can only be described as “stress.” The Volatility Index (VIX), a popular measure of market fear, has surged to levels not seen since mid-February. During its last peak, the S&P 500 was trading approximately 200 points lower. Such a discrepancy draws attention and stirs contemplation among investors regarding potential market undercurrents.

Adding to the unease are escalating geopolitical tensions in the Middle East. Statements like those from Netanyahu, asserting a strong retaliatory stance, contribute to the market’s skittishness. These factors, coupled with persistent inflationary pressures and potential signals from the gold market, paint a picture of investors bracing for more turbulence.

A telling statistic comes from the realm of real estate, where the Housing Affordability Index has plummeted to its lowest recorded levels, signaling broader economic strains.

When considering investor sentiment, metrics like the AAII Bull Bear index are nearing the upper echelon of historical data. Similarly, active equity manager exposure is reaching its historical peaks, suggesting that market participants are potentially overextended.

The relationship between the VIX and Federal Reserve balances is telling its own story, with the four-week rate of change in Federal Reserve reserves inversely moving against the S&P 500. This divergence poses a critical question: is the market due for a correction to align closer with the reserves?

The “second bear story” revolves around the Federal Reserve’s balance sheet, which has shrunk to its lowest level since early 2021. This decrease of $1.5 trillion from the peak in April 2022 sparks a debate over the extent of quantitative tightening required to counterbalance the significant quantitative easing that took place between March 2020 and April 2022.

Revisiting the bear narratives that once dominated market discourse, we find that many of these concerns never truly disappeared. They were simply overshadowed by the market’s willingness to look the other way. One such narrative is the considerable unrealized losses on investment securities, which hit a staggering $478 billion in the fourth quarter of 2023. Moreover, with the expiration of the Bank Term Funding Program, the banking sector’s vulnerabilities may come to the forefront once again.

The Federal Reserve’s reserves continue to diverge from the S&P 500, leaving investors to ponder the implications. As these indicators stretch further, the market may be due for a period of reckoning or realignment.

The calm of the past may have been deceptive, and the market’s current volatility could be signalling the return of fundamental issues that were never fully addressed. Investors are advised to keep a vigilant eye on these indicators and prepare for the possibility of a more dynamic and perhaps challenging market landscape ahead.