- The CBOE Volatility Index, also known as Wall Street's fear gauge, is indicating that uncertainty about the future remains elevated despite the strong rally in stocks.
- BTIG's Julian Emanuel and economist David Rosenberg examined the historical VIX data since 1990 and concluded that its current level usually portends market losses.
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There were a few days in March when investor fear was so rampant that trading halts became commonplace.
That unnerving period of frequent circuit breakers is long gone now — but there still remains a palpable sense of uncertainty about what the future holds for publicly traded companies.
For proof, look no further than Wall Street's so-called fear gauge formally known as as the CBOE Volatility Index, or VIX. It was near 36 on Friday, up 11 percentage points while stocks slumped, in keeping with its inverse relationship with the S&P 500. At that level, it was well above its long-run average of 19, according to data compiled by BTIG.
Perhaps the VIX was itself a tell-tale sign of the decline. After all, a rising VIX indicates that various S&P 500 index options that offer insurance against future losses are commanding higher premiums.
If history is any guide, the relatively elevated VIX may be signaling that more losses are afoot in the stock market.
"Investors should be mindful of the 2020 declines in stocks as VIX rose through 25 in late February, past 45, to peak at 85.47," said Julian Emanuel, BTIG's chief equity and derivatives strategist, in a recent client note.
He added, "In 30 years of data, VIX between 25 and 45 has been accompanied by large net declines for the S&P 500."
Emanuel's analysis of the VIX from its inception in 1990 through June 2020 showed that when it traded in a range between 25 and 45, the S&P 500 fell by a cumulative 79%. On a daily basis, the losses averaged out to -0.1%.
To be sure, the VIX traded in this range roughly one-fifth of the time under consideration, notes David Rosenberg, the chief economist & strategist of Rosenberg Research & Associates. But that does not make the VIX any less prophetic, in his view.
He noted that when the VIX traded between 30-35, the average monthly change in the S&P 500 was -1.1%. At 40 and above — where the index was trending towards on Friday — monthly losses averaged -4.3%.
Rosenberg further noted that the market's impressive 45% jump from its coronavirus-driven trough did not sufficiently drive down the VIX — at least when compared to history.
In 1990, the S&P 500's first 40% rally pushed the VIX down to 12. In 2002, a comparable rally compressed it to 13. In 2009, the VIX retreated to 24.
But in 2020, the VIX briefly bottomed near 25 before advancing to the zone in the 30s that Rosenberg and Emanuel consider dangerous. The historic volatility in March likely kept the VIX higher than usual this time around.
However, other experts are keeping close tabs on elevated levels of fear and uncertainty on Wall Street. After all, there is a lot to still worry about, including the recent rise of hospitalization rates in several states.
"While equity volatility should normalize further with a better macro backdrop, it is likely to remain elevated compared with long-run history in the coming months," said Christian Mueller-Glissmann, a managing director of portfolio strategy and asset allocation at Goldman Sachs.
He continued: "Our volatility regime model, which aggregates macro, macro uncertainty and market indicators, suggests that the high vol regime might linger. Uncertainty indicators in particular are still high due to the COVID-19 newsflow."
In other words, this is no time to be complacent. Emanuel reminded clients that unemployment is still historically high and the so-called second wave of infections is actually a fast-rising first wave in many states.
He recommends that investors cash in on lingering greed by identifying stocks where traders are overwhelmingly bullish, and then selling near-term, out-of-the-money calls. Boeing, Tesla, Delta Air Lines, and Spotify are a few of the companies he spotted with relatively flat skew, meaning traders are paying a greater premium for upside calls versus downside puts.
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