On Tuesday the Dow Jones Industrial Average notched its 17th record close since November 8, finishing just 25 points below 20,000. Steady gains in the wake of the U.S. presidential election have left many investors feeling exuberant about next year. But another bellwether of market strength, the CBOE Volatility Index, or the VIX, suggests that new risks lurk beneath the surface of this rally.

The VIX, known as the market’s fear gauge, traded near 11.4 on Tuesday, roughly in line with the historical lows of the past few years. However, expectations of price swings are rising. The CBOE VVIX Index, which monitors VIX volatility, is climbing even as the VIX itself holds near the bottom.

"What you’re starting to see is the market beginning to realize there is significant policy risk on the horizon," says Christopher Cole, founder and portfolio manager at Artemis Capital Management. The $100 million firm’s flagship vehicle, the Artemis Vega Fund, seeks to generate return by trading volatility. Cole points out that traders are looking ahead to major policy changes in the U.S. and possibly the European Union, given the number of elections on tap throughout the euro zone in 2017. "We think the market is significantly underpricing the possibility of a breakup of the EU," he adds.

While markets wait to learn the outcomes of approaching elections, some traders are also putting on positions in a bet that cyclical forces will drive volatility back up before the next round of elections does. "Market participants are looking to buy volatility while the VIX is at historic lows, so you have a lot of buyers expecting a reversion to the mean," Cole says. "Bidding up volatility with an expectation of mean reversion will naturally happen when the VIX is down this far." Expectations around mean reversion could also be fueling the idea that price swings will start soon.

Analysts at Schaeffer’s Investment Research highlighted another bearish signal in a research note published on December 8. That day the S&P 500 index hit 2,244, just shy of its 2,500 record, an important psychological number for investors. But the VIX closed 6.6 percent higher, at 13.03.

There have only been 23 days since 1990 when the VIX has climbed more than 5 percent while the S&P 500 also hit new highs, according to Schaeffer’s. Each time that happens, stocks slid soon afterward. "The S&P averages a loss both one day, week and month after a signal, and has averaged a subsequent three-month return of just 0.77 percent," the research note says. Since 1990 the S&P 500 has posted an average three-month return of 2.04 percent.

All of these signs indicate that investors and traders alike are trying to figure out where the VIX and the market are headed, but few have a clear picture. This year through December 19, VIX exchange-traded funds have attracted some $8.7 billion in inflows, Zacks Investment Research reports, a new record for the category. These products are meant to be held over the short term, and their popularity is already affecting the VIX.

"We’ve seen some days where these hedging programs come on using ETFs and they cause the VIX to move in lockstep with the market," says Rune Madsen, co-founder of volatility trading firm Runestone Capital. London-based Runestone’s strategy is based on VIX futures trading.

"There’s a lot of talk about volatility, but few people really understand how to play it," Madsen says. "There’s a lot of time decay in volatility, and it’s very easy to get on the wrong side of a trade if you look too far out." For its part, Runestone trades VIX futures over 24-hour holding periods using a systematic strategy.

Artemis’s Cole agrees. Institutional portfolios have spent the past few years orienting to a low-volatility environment and optimizing to passive strategies like smart beta to capture factor-based moves in lieu of big price swings, he says. "I think it’s time for institutions to start putting some chips on the table for change," Cole argues.

In his view, many institutional portfolios are optimized to a market that has been driven by one of the most accommodative monetary policy regimes in history. "We expect that regime to change and change fast," Cole says. "You can have high stock prices and high volatility, but a portfolio built to handle that isn’t oriented to passive index products."

Cole suggests looking to pair traditional investments with actively managed defensive assets that profit from change, namely commodity trading advisers, macro strategies, and active volatility managers. 

Insurance companies may also emerge as key players, adding volume and driving activity. Runestone’s Madsen notes that insurers, which are traditionally big participants in the market for products like VIX futures, could strike a more defensive posture if these warning signs become a trend.

But to pull it off, traders with large portfolios will have to position themselves to take advantage of short-term gains. "We have seen recently a pattern of volatility spikes on news or signals, so you have to be prepared to react quickly," Madsen says.