CREDIT SUISSE: There are 3 things that could drive the stock market crazy in 2018

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Getty Images / Scott Olson

  • Stock market volatility was locked near record lows for much of 2017, and Credit Suisse says it has nowhere to go but up.
  • The firm highlights three things that could drive a surge in price swings this year.

Even as the S&P 500 turned in a monster 2017, it was a trade betting on a market standstill that offered the best opportunity for profit.

Exchange-traded products linked to the so-called short-volatility strategy surged almost 200% in the last year, smashing returns for even the hottest tech stocks. In turn, price swings in US stocks were virtually non-existent – a dynamic reflected by the CBOE Volatility Index, or VIX, which spent most of 2017 locked near record lows.

Fear not, says Credit Suisse, which sees more volatility just around the corner. The firm forecasts that the VIX will trade at a median of 12.5 in 2018, higher than the 10.9 level from last year.

Credit Suisse identified three things that could cause wild stock price swings and spiking volatility this year:

1) Sharply higher bond yields

Credit Suisse says that its 10-year Treasury yield “danger level” for stocks is 3.5%. Treasuries were trading near 2.55% as of Tuesday morning, meaning that the ongoing bond market selloff will have to continue in order for this threshold to be breached.

“In order to get such a rapid rise in yields, we would need to see a sharp acceleration in US wage inflation and a much more hawkish Fed,” Credit Suisse equity derivatives strategist Mandy Xu wrote in a client note.

The firm notes that the only time there’s been an empirical relationship between higher rates and a higher VIX is when yields rise sharply in response to surprise Federal Reserve tightening measures. For evidence of this, look no further than the so-called “taper tantrum” that transpired in May 2013 after then-Fed chair Ben Bernanke made surprising comments about slowing asset purchases:

The 2013

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The 2013 “taper tantrum” offers a cautionary tale for traders when the Fed surprises the market.
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Credit Suisse

2) A trade war

In the near term, Credit Suisse is looking at the March deadline for talks to modernize NAFTA, noting that there’s been little progress up to this point.

The firm also sees mounting risk around a possible “full-scale trade war” with China as US trade penalties risk “tit-for-tat retaliation” from China.

Meanwhile, there’s been speculation that the US may exit NAFTA entirely, something that Credit Suisse notes has been factored into the Mexican market. However, there’s been no such comparable risk premium priced into US equities, either on a single-stock or whole market basis, the firm says.

Mexican markets are pricing in a possible US exit from NAFTA, while US equities haven't.

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Mexican markets are pricing in a possible US exit from NAFTA, while US equities haven’t.
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Credit Suisse

3) Geopolitical risks

This is perhaps the most obvious possible negative catalyst for the US stock market, and also potentially the most dangerous. Credit Suisse highlights the following five areas as inspiring the most worry (all bullets verbatim):

  • North Korea: “fire and fury,” escalation of rhetoric/sanctions
  • Middle East: Iran, Syria, Saudi Arabia > upside risk for oil prices
  • United States: government shut down, Russia investigation
  • Europe: Italian elections, Catalonia independence, etc.
  • Cyberattacks: from state and non-state actors