Wall Street’s so-called fear gauge has been subdued this year, in a “mysterious shrinking” pattern, which is a bullish signal for stocks, according to DataTrek Research.
Declines for the Cboe Volatility Index VIX fear gauge come despite persistent concerns about inflation and high interest rates.
“We have been saying for several months that a low VIX is a sign that US stocks are in a bull market, rather than being overly delusional about the obvious challenges ahead,” said Nicholas Colas, co-founder of DataTrek, in an emailed note. Monday. “However, we still believe the coming weeks will be choppy.”
The indicator, known by the ticker VIX, is down more than 35% so far this year and is trading below its long-term average, according to data from FactSet. The trading levels are derived from options contracts tied to the S&P 500, the U.S. stock benchmark that is up 16% through 2023 through Monday.
Last week, the VIX hit a “new post-pandemic crisis low” and ended below 13 on September 14, a “rare event” for the index that was a positive sign for stocks over the next three months, Colas’ note showed. That’s even if it suggests the “jerkyness” will continue in the short term, he said.
On Monday, the VIX closed at 14, well below its long-term average of around 20. The measure ended at 12.8 on September 14.
“On the face of it, this doesn’t make much sense,” Colas said. “The VIX is supposed to be Wall Street’s ‘Fear Index’ and it seems like “there’s plenty to be afraid of right now.”
‘Cloudy view’
Colas mentioned several areas of concern, including the uncertainty surrounding inflation, the recent rise in oil prices CL00,
and “a cloudy view” of how long the Fed Reserve will keep rates high, for its reasoning for why investors might feel anxious.
The Fed has tried to slow the rise in the cost of living in the US through its restrictive monetary policy, aggressively raising interest rates over the past eighteen months.
There’s also the recent rise in government bond yields that has weighed on stocks of late, with 10-year government bond yields “looking set to reach new multi-decade highs,” Colas said.
The yield on the 10-year Treasury bond BX:TMUBMUSD10Y ended Monday at 4.318%, according to Dow Jones Market Data. That’s about the level of late 2007, FactSet data show.
‘Seasonal spikes’ in volatility
The VIX had started 2023 trading below its long-term average, with Colas saying in January that it looked a lot more like 2021, a year when stocks rose, rather than 2022, when stocks tumbled as the Fed quickly raised rates.
To see: Wall Street’s ‘fear gauge’ VIX looks more like 2021 than 2022 as US stocks rise this year, says DataTrek
Meanwhile, September and October are known for their “seasonal peaks in stock market volatility,” Colas said.
US stocks are down so far this month, following a decline in August. The S&P 500, which fell 1.8% last month, fell 1.2% from September through Monday, FactSet data show.
The S&P 500 SPX closed 0.1% higher on Monday, while the Nasdaq Composite COMP and Dow Jones Industrial Average DJIA each finished about flat, as investors digested new data showing that confidence among homebuilders fell this month due to high mortgage rates.
Investors in the stock market also keep an eye on the inverted yield curve in the U.S. Treasury market, or when short-term rates rise above long-term rates, as that has historically preceded a recession.
There is also some concern about the increased popularity of zero-day options in the stock market, because “you would think that their increasing use would increase expected volatility, rather than decrease it,” Colas said.
“We doubt that options firms have just walked away from trading 30-day options” on S&P 500 futures, he said. “If there is money to be made in a financial asset, someone will invariably trade it.”
The Cboe Volatility Index measures the 30-day expected volatility of the U.S. stock market.
“What the ultra-low VIX tells us is that none of these concerns matter enough to largely offset the fundamentally strong view of US corporate earnings and the belief that the Federal Reserve is done raising rates,” Colas said . “Stocks are dismissing the possibility of a recession in the next one to two years, regardless of what an inverted yield curve has historically said at that point.”