Looking Beyond the VIX Shows Fever in U.S. Stocks May Be Healing

Taking a Closer Look at Market Volatility
  • Short-term vs long-term volatility has signaled market bottoms
  • Volatility `very good tool' for anticipating rebounds: Weeden

The storm of selling that greeted U.S. equity investors returning from holiday break caused a real-time measure of expected volatility to post its biggest first-day jump in history. A longer-term gauge is showing far less panic.

Pushed up as almost $300 billion was wiped from the Standard & Poor’s 500 Index Monday, the world’s most famous equity sentiment gauge, the Chicago Board Options Exchange Volatility Index, has jumped 32 percent since Christmas to 20.7. At the same time, an index of expected stock swings that looks further into the future, a three-month measure known as the VXV, is up just 8 percent over the same stretch.

While VXV typically trades at a higher level relative to the VIX, that premium has narrowed in the last week. The two gauges are now almost equal, which in the past has heralded a rebound in stocks.

“It’s a very good tool to guide investors but it’s oversimplifying to say the line shot up so buy the market -- that’s where the art comes in,” said Michael Purves, chief global strategist at Weeden & Co. in Greenwich, Connecticut. “If we start to see some stabilization of the front month, that will probably be a helpful bottoming signal.”

In other words, should the VIX’s rally lose steam, equities may be poised to recover. The VIX was little changed Tuesday at 21 after a 14 percent jump on Monday. The three-month gauge slid to 21.4 following an 11 percent climb, bringing the ratio between the two to 0.97. That’s the highest since Dec. 18. On that day, the S&P 500 extended a decline, then erased most of those losses the next three days.

Since the beginning of the bull market, the S&P 500 gained an average 0.46 percent in the three sessions following instances when the ratio reached a value of one. That compares with an advance of 0.2 percent on average in a three-day span since March 2009.

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