This post was originally published on this site
Wall Street’s so-called fear gauge has been subdued this year, in a “mysterious shrinking” pattern, that’s a bullish signal for equities, according to DataTrek Research.
Declines for the Cboe Volatility Index
VIX
fear gauge come despite continued worries over inflation and elevated interest rates.
“We’ve been saying for several months that a low VIX is a sign that U.S. stocks are in a bull market rather than being excessively delusional about the obvious challenges ahead,” said Nicholas Colas, co-founder of DataTrek, in a note emailed Monday. “We still believe the next few weeks will be choppy, however.”
The gauge, known by its ticker VIX, has dropped more than 35% so far this year and is trading below its long-term average, according to FactSet data. Its trading levels are derived from options contracts tied to the S&P 500, the U.S. stock benchmark that has rallied 16% in 2023 through Monday.
Last week the VIX made “a new post-pandemic crisis low,” finishing below 13 on Sept. 14 in a “rare occurrence” for the index that was a positive sign for stocks over the next three months, Colas’s note shows. That’s even if it suggests near-term “choppiness” will continue, he said.
On Monday the VIX closed at 14, well below its long-run average of around 20. The measure ended Sept. 14 at 12.8.
“At first glance, this makes little sense,” Colas said. “The VIX is supposed to be Wall Street’s ‘Fear Index’ and it would appear “there’s plenty to be fearful of just now.”
‘Cloudy picture’
Colas cited several areas of concern, including uncertainty surrounding inflation, the recent jump in oil prices
CL00,
and “a cloudy picture” of how long the Fed Reserve will keep interest rates elevated, for his rationale as to why investor might feel fearful.
The Fed has been trying to slow the rise in the cost of living in the U.S. via its restrictive monetary policy, lifting its benchmark rate aggressively over the past 18 months.
There also has been the recent climb in Treasury rates that has weighed on stocks lately, with 10-year Treasury yields looking “set on making new decade-plus highs,” said Colas.
The yield on the 10-year Treasury note
BX:TMUBMUSD10Y
finished Monday at 4.318%, according to Dow Jones Market Data. That’s around levels seen in late 2007, FactSet data show.
‘Seasonal peaks’ in volatility
The VIX had kicked off 2023 trading below its long-run average, with Colas saying in January that it was looking a lot more like 2021, a year in which stocks rallied, rather than 2022, when equities tanked as the Fed rapidly hiked rates.
Meanwhile, September and October are known for “seasonal peaks in equity market volatility,” according to Colas.
U.S. stocks have slumped so far this month, after falling in August. The S&P 500, which dropped 1.8% last month, is down 1.2% in 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 fresh data showing a drop in confidence among homebuilders this month amid elevated mortgage rates.
Stock-market investors also have been monitoring the U.S. Treasury market’s inverted yield curve, or when shorter-term yields climb above long-term rates, as that historically has preceded a recession.
There’s also some concern over the increased popularity of zero-day options in the stock market, as “you’d think their growing usage would push anticipated volatility higher, not lower,” Colas said.
“We doubt options desks 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 invariably trades it.”
The Cboe Volatility Index measures 30-day expected volatility of the U.S. stock market.
“What the ultra-low VIX is telling us is that none of these concerns matter enough to offset a fundamentally strong picture for U.S. corporate earnings and the belief that the Federal Reserve is largely done hiking rates,” said Colas. “Equities are dismissing the possibility of a recession over the next 1-2 years, no matter what an inverted yield curve has historically said on that point.”
