All eyes on the VIX and the S&P 500 to see if we are in for a very ugly summer. Today might have seemed like a strong rough patch, but in reality we have yet to see a complete meltdown or pervasive protection buying. The VIX is actually just hitting its May upside barrier for the fourth time this month:
In trying to assess the situation there is one very interesting dichotomy occurring in the US markets. Interest rates continue to fall lower while the equity market has remained stubbornly high. If you look at the 10 year treasury rate versus the S&P 500 price index you can see fairly strong correlation over the last 11 years:
The 10 year treasury at a sub 3% yield does not seem as if we should be overly exuberant. That said, the current earnings on the S&P 500 suggests an earnings yield (earnings over price) of about 6.5%. This suggests that you would have to cut earnings in half for the earnings yield on the S&P 500 to be equal to the S&P 500. Would you rather own a basket of stocks that are currently earning a yield that is twice that of a 10 year treasury or would you like to lock in that the treasury rate for 10 years with no potential for upside and put your money at risk to upside inflation?
I could see a correction setting us back to 1200 on the S&P 500, but at this time I would view it as a buying opportunity and chance to have some fun with volatility.