C.J. Lawrence Weekly – S&P 500 On Track for “Quiet” Year Despite Spike in VIX
The Chicago Board of Trade (CBOE) developed and launched the Market Volatility Index (VIX) in 1993, based on the Sigma Index and methodology created by Menachem Brenner and Dan Galai in 1986. Today it is a commonly referred to as the “fear gauge” because of the perception that higher volatility index readings represent negative stock market action. In fact, the VIX does tend to spike during meaningful stock market declines and remains low during periods of stock market appreciation. But the VIX is often misperceived as a measure of equity price action. Instead, the VIX Index represents the anticipated level of volatility of the S&P 500 Index over the next 30 days, calculated by aggregating the implied volatility of hundreds of SPX option spreads. Thus, while the VIX may not be a good indicator of future stock market returns, it is a good measure of near term institutional investor sentiment and provides insight into the level of protection they are seeking in choppy markets.
The five-year average for the VIX now stands at 14.7. It spiked to 25.2 on October 24 and closed last week at 20.2. The current reading suggests that options market participants believe there is an elevated level of equity risk in the market over the next 30 days and are seeking protection from that risk. As the daily VIX Index chart shows, the reading can change quickly and tends to be more reactive than proactive. Nonetheless, it is an important trader tool that can also help longer term investors identify over-sold markets and attractive entry points.
Media headlines, suggesting that the recent spike in the VIX is associated with record high volatility in stocks, miss the mark. An analysis of historical patterns of annual high and low prices suggests that stock price differentials have been muted in 2018. The S&P 500 Index hit a year-to-date closing high on October 3rd at 2,925.51 and a year-to-date closing low of 2,581.00 on Feb 8. That represents a 13.3% differential between high and low. If it holds that level, 2018 will deliver the 5th lowest level of high-low price differential over the past 50 years. The compressed high-low price gap and paltry 1.8% year-to-date price return suggest that S&P 500 Index volatility isn’t living up to the hype. Instead, what keeps managers and investors awake at night is the pace at which the market gyrates within the high-low boundaries. The good news is that following bottoms in the S&P 500 30-day rate of change, stock prices tend to deliver attractive returns over the next ninety days. After the troughs in August of 2015 and February of 2016, the S&P 500 Index appreciated 11.8% and 12.8% respectively over the subsequent 90-day periods. Periods that follow coincidental spikes in the VIX and troughs in the S&P 500 Index 30-day rate of change have historically represented good entry points for stocks. Long-term investors would be wise to keep their favorite idea shopping lists handy.
Terry Gardner Jr. is Portfolio Strategist and Investment Advisor at C.J. Lawrence. Contact him at firstname.lastname@example.org or by telephone at 212-888-6403.