To The Moon

$Cboe Volatility Index(VIX)$

When Weakness Looks Like Strength

In a year where economic headlines often veer negative—disappointing job growth, declining consumer sentiment, and mounting geopolitical concerns—it would be reasonable to expect markets to struggle. Yet the reality unfolding in 2025 is anything but conventional. U.S. equity markets are not just shrugging off bad news—they’re rallying on it.

As of early August 2025, the S&P 500 is trading within 2% of all-time highs, and the Nasdaq has already eclipsed its previous peak. Meanwhile, the CBOE Volatility Index (VIX)—often referred to as Wall Street’s “fear gauge”—has plummeted below 12, signaling the return of extreme complacency. This is occurring even as the economy shows signs of fatigue, with decelerating GDP growth, soft payroll numbers, and declining manufacturing activity.

This contradictory dynamic—bad news fueling risk appetite—raises a crucial question: are we witnessing a sustainable new bull market fueled by dovish central bank expectations and disinflation, or are investors being lulled into a false sense of security?

Market Moves Defy Economic Gravity

Equity markets have climbed a wall of worry through the summer of 2025. The second quarter brought a mix of lackluster data: U.S. GDP growth slowed to an annualized pace of just 0.9%, nonfarm payrolls consistently missed expectations, and consumer spending softened across discretionary categories. Yet stocks continued to rise.

Behind this optimism lies a growing belief that the Federal Reserve is preparing to pivot more aggressively toward rate cuts. With inflation now tracking close to the Fed’s 2% target—core PCE is down to 2.1% year-over-year—and wage pressures softening, markets are pricing in a 50% chance of a rate cut as early as the September FOMC meeting.

The current narrative appears to be: “Bad news is good news.” Any sign of economic deceleration is interpreted as further justification for monetary easing. That, in turn, boosts equities—especially growth and tech stocks whose valuations are highly sensitive to interest rates.

This dynamic has caught many investors and fund managers off-guard. Defensive positioning earlier in the year, based on concerns about earnings degradation and macro headwinds, has underperformed. The S&P 500 is up nearly 18% YTD, and the Nasdaq 100 has surged 24%, driven by AI optimism, declining yields, and multiple expansion.

Performance Overview and Market Feedback

The key market indices have delivered robust gains through the first seven months of 2025:

• S&P 500: +17.8% YTD

• Nasdaq 100: +24.2% YTD

• Russell 2000: +12.3% YTD

• Dow Jones Industrial Average: +10.5% YTD

At the same time, the VIX has remained unusually low—consistently below 15 for much of the summer and recently breaking below 12, levels not seen since early 2020. Low volatility readings reflect a general lack of hedging demand and suggest that investors perceive little near-term risk.

However, under the surface, there are signs of fragility. Market breadth remains narrow, with a disproportionate share of gains concentrated in mega-cap tech. Additionally, corporate earnings guidance for Q3 has been tepid, and the bond market—often a more sober barometer—shows caution. The 10-year Treasury yield has fallen back to 3.55%, and yield curves remain inverted, signaling concerns about future growth.

Investors face a curious setup: historically low volatility readings coupled with elevated macro uncertainty. The question becomes whether it’s wise to continue riding the rally—or begin reintroducing hedges as a defensive measure.

The Mechanics of "Bad News is Good News"

This paradoxical market behavior is not new. “Bad news is good news” has been a recurring phenomenon during cycles of Federal Reserve easing. But in 2025, the effect is amplified by a unique convergence of forces:

1. Monetary Policy Expectations Markets believe the Fed’s tightening cycle is over. With inflation trending downward and growth softening, the bias has shifted toward accommodation. Futures markets now imply at least two rate cuts by March 2026.

2. AI and Productivity Narrative Investors continue to bet on the secular theme of artificial intelligence and its transformative impact on corporate profitability. Mega-cap names like NVIDIA, Microsoft, and Alphabet are seen as structural winners, regardless of near-term economic fluctuations.

3. Global Disinflation Eurozone inflation has also declined materially, and China’s economy continues to flirt with deflation. A globally synchronized disinflation trend is interpreted as removing a major headwind to asset prices.

Yet this setup is inherently fragile. Should inflation surprise to the upside—or should disinflation morph into outright deflation and stall corporate pricing power—the bullish narrative could unravel quickly. Additionally, if job losses accelerate, consumer demand could deteriorate, pressuring earnings.

Investment Highlights: Opportunities and Risks in a Low VIX World

Despite the bullish price action, prudent investors should be mindful of key risks—and consider tools to hedge portfolios even in the face of complacency. Below are the primary investment themes to monitor:

1. Equity Momentum Is Still Intact—but Narrow The rally has been led by a handful of dominant players in tech and communication services. Equal-weighted S&P indices continue to lag the cap-weighted version. This concentration risk is reminiscent of previous late-cycle rallies and warrants careful sector exposure management.

2. Valuations Are Stretched The forward P/E ratio for the S&P 500 is now above 21x—well above historical averages. Tech valuations are even more aggressive, with many large-cap AI beneficiaries trading at 30x–40x forward earnings. Any earnings miss or rate repricing could trigger sharp drawdowns.

3. Low VIX ≠ Low Risk The VIX falling below 12 may seem like a sign of stability, but historically, such levels precede future volatility spikes. Volatility tends to mean-revert, and when markets become too one-sided, even small surprises can generate exaggerated reactions.

4. Hedging Costs Are Cheap—for Now Because implied volatility is low, the cost of buying protective puts or volatility products is more attractive. Long-term investors with large equity exposure might consider tail-risk hedges or structured notes to manage drawdown risk without exiting positions entirely.

5. Bond Market is Sending a Mixed Message The 2s/10s yield curve remains inverted—a classic recession signal. At the same time, credit spreads remain tight. This divergence suggests the bond market expects growth to slow but no major credit event—yet.

Behavioral Dynamics: FOMO and the Institutional Chase

Another driver of this market resilience is institutional behavior. After being underweight risk assets for much of 2024, many hedge funds and asset managers are now playing catch-up. The fear of missing out (FOMO) is creating momentum-driven buying, especially in sectors tied to AI, automation, and semiconductors.

Fund flow data from EPFR Global shows that U.S. large-cap equity funds have received over $60 billion in inflows since April—reversing outflows from Q1. Meanwhile, positioning surveys show that active manager exposure to equities is near 80th percentile historical levels, up from the 30th percentile earlier this year.

This is not irrational exuberance—but it is risk-on behavior rooted in narrative-driven optimism. And it’s occurring at a time when earnings growth is decelerating and consumer sentiment remains muted.

Soft Landing or Illusion of One?

Perhaps the most debated macro question today is whether the U.S. economy is truly on the path to a soft landing—or simply enjoying the calm before a more severe deceleration. Bulls argue that the worst of inflation is behind us, and that disinflation allows central banks to engineer a “Goldilocks” environment. Bears counter that key lagging indicators—like unemployment—have yet to fully reflect the cumulative impact of 500+ basis points of Fed tightening.

Recent data offers mixed signals:

• Unemployment Rate: Ticked up slightly to 4.1%, still historically low but rising.

• Consumer Confidence: Falling sharply, especially among lower-income groups.

• ISM Services and Manufacturing: Below 50, indicating contraction.

• Corporate Earnings Growth: Slowing, with several sectors guiding lower.

In short, the data is consistent with a late-cycle economy—one that can remain stable for a time but is susceptible to shocks. Investors need to weigh the probability of a shallow slowdown versus a deeper downturn, especially as rate cuts begin to materialize.

Should You Keep Hedging in a Falling VIX Environment?

Given the market’s low-volatility regime and bullish trend, it may feel counterintuitive to hedge. Yet historical analogs suggest this is precisely when hedging can be most effective and cost-efficient.

Consider the following options:

1. Long-Dated Puts: With volatility low, long-dated out-of-the-money puts on major indices like SPY or QQQ can offer asymmetric downside protection.

2. Volatility ETFs: Instruments like VIXY or VIXM provide a way to express views on future volatility expansion.

3. Risk-Parity Adjustments: Rebalancing portfolios to reduce equity beta while maintaining return targets via alternatives like infrastructure, dividend stocks, or gold.

4. Dynamic Hedging Strategies: Quantitative overlays that add or remove hedges based on trend, sentiment, or macro signals.

While hedging may modestly reduce upside capture, it also offers protection against regime shifts—such as a sudden inflation resurgence, geopolitical event, or earnings collapse.

Conclusion: Complacency Is Not a Strategy

Markets are rallying, volatility is falling, and risk appetite is back. But this is not the time for overconfidence. The fundamental backdrop remains uncertain, and the current rally is being driven more by expectations of central bank support than improving earnings or macro strength.

Investors must acknowledge the paradox of today’s market: equities are surging on weak data, and volatility is collapsing even as uncertainty rises. This disconnect could persist in the short term—but will not last forever. Now is the time to build resilience into portfolios, review hedging frameworks, and avoid the temptation of chasing returns without safeguards.

Key Takeaways

1. Markets are rising despite soft macro data, fueled by disinflation and Fed pivot hopes.

2. The VIX has fallen below 12, suggesting extreme complacency and low hedging activity.

3. Narrow market breadth and stretched valuations heighten correction risks.

4. Cost-effective hedging strategies are now available, given low implied volatility.

5. Investors should balance optimism with risk management, particularly as earnings growth slows.