Fear Gauge at 11-Week Low May Give Stocks the ‘All Clear’

October 16, 2019

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Bloomberg – The drop in U.S. equity volatility to a three-month low is being taken as a positive sign for stocks by market watchers, rather than one of complacency.

The Cboe Volatility Index slid a fifth straight day Tuesday to 13.54, the lowest since July 29. In the three times this year that Wall Street’s so-called fear gauge fell below 14 after spending a few weeks above it, shares rallied further twice, according to Sundial Capital Research Inc. founder Jason Goepfert.

“Historically, it has been more of a positive than a negative,” he wrote Tuesday about the VIX’s move. “It’s not so low that it has proven to be a sign of complacency.”

Looking back further, among about 30 instances since 1990 when the VIX declined below 14 for the first time in more than three weeks, only one of the signals preceded a loss over the next six to 12 months, he said.

Of course, there may be other factors in the low VIX, as well. Nomura’s Charlie McElligott noted Wednesday that exchange-traded products based on the gauge, and their rebalancing mechanisms, “completely overwhelm market capacity into their ‘rolls’ from front-month to second-month.”

That volume in the rolls “is far beyond market capacity to digest, and is the largest reason” that the front-month VIX future has hit local lows on the day ahead of expiry in each of the past seven months,” according to McElligott. But after that it’s back to “again seeing VIX grind higher,” he said.

After a relatively calm September, investors were whipsawed at the start of October as U.S.-China trade tensions resurfaced and global economic data weakened. The S&P 500 Index has moved at least 1% on six occasions this month, versus only two 1%-plus moves in the whole of September.

For Schaeffer’s Investment Research, the drop in the gauge of equity swings is also a signal of upside for stocks.

“The ‘all clear’ signal for a near-term decline in volatility triggered as of Friday’s close, as the VIX closed below its 200-day moving average,” Todd Salamone, senior vice president of research at Schaeffer’s, said in a note Monday.

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