warning sign

Monday’s events in Boston were a terrible tragedy. The loss of life was devastating and all of us at BlackRock are praying for the city today. For investors, the news was a tragic reminder that markets still face unknown risks from terrorism and geopolitics, especially considering that there are more than a few trouble spots in the world (the Korean peninsula and Syria to name just two).

In my recent spring outlook piece, I included such “unknown unknowns” as a scenario that could potentially spark a market reversal.

The explosions at the Boston Marathon shortly before the US market close unnerved investors who were already digesting weaker-than-expected Chinese and US growth numbers. All three major US indices tumbled, with the Dow suffering its worst one-day point drop since November.

Despite Monday’s tumble, markets remain vulnerable to shocks – geopolitical as well as economic. While volatility spiked on Monday, it still remains well below the historic average.

This is evident in the recent performance of a critical indicator of market sentiment: the VIX or CBOE Volatility Index (otherwise known as the fear gauge). The index tracks the implied volatility in S&P 500 options. Low levels suggest that investors are feeling sufficiently confident that they are not paying much of a premium to buy insurance – in the form of put options – on the market. In other words, they don’t believe that markets will move much up or down, meaning there’s not likely to be a lot of bad news.

Prior to Monday, the VIX was close to its lowest level since before the financial crisis. While volatility spiked on Monday to 17.27, that is still below the long-term average of around 20 and well below the average seen between 2008 and 2012.

What does this mean for investors? With volatility still low and the economy slowing, the risk going forward is that any other unexpected events, whether a European banking crisis or something more violent, would be an unexpected shock to investors who have become accustomed to a steady stream of benign headlines.

Still, I wouldn’t advocate getting out of the market in anticipation of another potential crisis that may not occur and is impossible to predict. While I expect that US gains will be harder to come by in the second quarter given a slowing economy and that a lot of good news has already been discounted, I would still maintain a market position in US equities, where fundamentals continue to look ok.

Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog.  You can find more of his posts here.

Source: Bloomberg, The Wall Street Journal