Looking at the current chart, market complacency increased modestly in August. The average VIX reading for the month declined from 17.6 in July to 17.5 in August. The forward-looking P/E ratio for the S&P 500, on the other hand, increased slightly during the month, rising from 21.1 to 21.4. The combination of lower volatility and higher valuations caused the market complacency index to increase from 1.20 in July to 1.22 in August. The index now sits at its third-highest level since the start of the pandemic; however, it is slightly below June’s 1.26 reading.

Readings above 1.2 have historically been a signal that market complacency is at potentially concerning levels. So, the fact that the index remained at this important level for the third month in a row is worth monitoring. Given the fact that complacency remains near concerning levels, we have left this indicator at a yellow light for now, with a downgrade to red possible if we continue to see complacency rise in the months ahead.
Signal: Yellow light

Conclusion: Market Risks Remain Despite Recent Rally
Economic fundamentals showed slowing growth in August, as concerns surrounding the recent increase in cases served as a headwind during the month. We saw service sector and consumer confidence decline notably during the month, which is a bad sign for future spending growth. We also saw the pace of hiring slow, with much of the slowdown concentrated in the hard-hit retail and leisure and hospitality sectors. It should be noted that while the pace of economic growth slowed during the month, the reports did show a continued economic recovery, just at a slower pace compared with earlier in the spring and summer.

As we saw in July and August, the pandemic represents a risk for markets, as rising concerns over the Delta variant led to some short-lived equity market volatility in both months. Despite the modest volatility in July and August, markets have largely remained resilient, as seen by the swift recoveries following the bouts of volatility.

Ultimately, the path back to a more normal economic environment is likely going to be long, and we can expect setbacks along the way, as we saw in August. Given the fact that the indicators that we track in this piece remained at a yellow light or better despite the slowdown in the pace of the recovery, we have left the overall market risk level at a yellow light for now. But the recent slowdown could lead to further volatility in the months ahead.

Brad McMillan is the chief investment officer at Commonwealth Financial Network.

Sam Millette, manager of fixed income on Commonwealth's Investment Management Research team, assisted with this article.

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