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Why the VIX Is Set to Spike Even Higher

NEW YORK (TheStreet) -- With the VIX "fear index" still wallowing in the teens and the S&P 500 relentlessly making new highs, "complacency" has been the word most commonly thrown around this year to describe the stock market.

But there are signs creeping in that the market has been anything but complacent in recent weeks. Trading volume has been light, with the August lull being just partly to blame, and Treasury yields have declined to 52-week lows. Yields pierced 2.4% late Thursday night, after President Obama announced plants to go forward with an air strike in Iraq. The 10-year note was surging 11/32, driving the yield to 2.375% Friday without much help from the Federal Reserve as it continues to taper its bond-buying program.

The main reason volume has been so thin and Treasury yields are being pressured is investors have been de-risking from stocks and flowing out of junk bond funds and high-yield bond funds in search of safety. They want a place to hide right now. That correlation can be clearly seen in the chart above, which shows the inverse relationship of high-yield corporate bonds, tracked by the iShares iBoxx High-Yield Corporate Bond Fund (HYG), vs. the VIX.


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The disruptive forces are bearing down from everywhere -- the friction between the West and Russia over Ukraine remains strong, with the Kremlin recently slapping one-year agricultural sanctions on Western nations. Tensions in Iraq have escalated to a point where rebels have seized the country's largest dam and the U.S. has begun limited bombing of militant targets to protect Americans and Iraqi citizens there. The Ebola scare and containment fears have led to flashbacks of the early 2000 SARS outbreaks and reminders of the bird flu.

It seems reasonable that geopolitical tensions could get worse from here or just not improve for a very long time, especially as it pertains to Russia. Russian President Vladimir Putin's iron grip on his country and ability to steer it as he wishes on the world stage will continue to come at the expense of Western interests.  

"Putin can ride out the storm a lot longer than any other politician in the world," said Luke Rahbari, chief risk officer at Stutland Volatility Group and a veteran options trader. "He can keep going at this for a while." With the sanctions, Europe's economy has become even more vulnerable lately, and that impact could bleed into the U.S. economy and elsewhere.

The flock to Treasuries is expected to intensify when the Fed abandons its role in driving the hunt for yield since 2008.

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