I always have my eyes open for significant data series to add to the Control Panel. Today, a Wells Fargo Economics report mentioned one I never heard of before: Economic policy uncertainty. This sounds a lot like VIX but they are different.
MEASURING ECONOMIC POLICY UNCERTAINTY
by Scott R. Baker, Nicholas Bloom and Steven J. Davis, NATIONAL BUREAU OF ECONOMIC RESEARCH, October 2015
We develop a new index of economic policy uncertainty (EPU) based on newspaper coverage frequency.
Several types of evidence – including human readings of 12,000 newspaper articles – indicate that our index proxies for movements in policy-related economic uncertainty. [Note that “proxies” is a verb that means “acts as a proxy for”.] …
Our index reflects the frequency of articles in 10 leading US newspapers that contain the following triple: “economic” or “economy”; “uncertain” or “uncertainty”; and one or more of “congress”, “deficit”, “Federal Reserve”, “legislation”, “regulation” or “White House”…
Using firm-level data, we find that policy uncertainty raises stock price volatility and reduces investment and employment in policy-sensitive sectors like defense, healthcare, and infrastructure construction. At the macro level, policy uncertainty
innovations foreshadow declines in investment, output, and employment in the United States… [end quote]
Between 1985 and today, there have been several spikes over 300 but only three over 400: The Great Financial Crisis in September 2008 and Covid-19 in early 2020.
And January through March 2025.
I have often noted that a sure sign of a financial crisis (which is NOT the same as a stock market bear) is a combination of CBOE Volatility Index (VIX) over 50 coupled with a Financial Stress Index over 5. This has only happened twice since 1993 and both times elicited massive emergency Quantitative Easing from the Federal Reserve.
Very rare signals can be sharp indicators for attentive investors. The coupling of very high economic policy uncertainty with a historically high CAPE is probably a danger signal for the stock market.
VIX is not unusually high at this time. The CBOE Volatility Index (VIX) is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index (SPX). Because it is derived from the prices of SPX index options with near-term expiration dates, it generates a 30-day forward projection of volatility.
The very high Economic policy uncertainty coupled with relatively low VIX shows that investors (many of which are trend-following computer programs) don’t expect sudden, sharp drops in the SPX. Investors are still relatively optimistic and are investing on every whiff of possible good news even though the news changes daily.
Being whipsawed isn’t good for the real economy since corporate decision makers will wait before investing in capital equipment and employees until they have more certainty. This can reduce GDP growth but it will take more than 30 days (VIX) to see the results.
Wendy