Before popping back up this week, the VIX Index briefly fell below 12 last week, reaching the lowest level since right before Covid. The VIX is a measure of the expected volatility of the S&P 500 Index over the following 30 days, and it is derived by the market price of call and put options on the S&P 500 itself. High readings of the VIX tend to occur during volatile periods for the market, when investors are fearful and options-based hedging strategies are in high demand. Historically, those periods offer attractive opportunities to increase exposure to stocks at a discount and reap above-average returns on a forward-looking basis. Conversely, low readings of the VIX tend to occur during periods of market calm and investors complacency. By the same token, should a low VIX be used as an opportunity to reduce exposure to stocks? It is often said that bull markets need a wall of worry to climb. Does a sub-12 VIX mean that the wall of worry has crumbled and that the bull market may be running out of fuel?
VIX Index Back to Pre-Covid Levels
Source: Bloomberg, as of 5/29/2024
The stats below, based on the full history of the VIX going back to 1990, clearly say otherwise. While the table clearly shows that elevated levels (i.e. > 28.5 or top decile) of the VIX tends to be followed by very strong returns, it also shows that low levels (i.e. < 12 or bottom decile) of the VIX tend to be followed by somewhat better-than-average returns. Moreover, a low VIX also tends to be followed by much shallower drawdowns than average. In other words, when investors expect volatility to stay low, they are proven correct more often than not. As the chart below shows, low VIX readings are most often seen during bull markets, not at market tops or during bear markets.
Low VIX Index Associated with Above Average Returns and Below Average Volatility
Source: CW Advisors, Bloomberg, as of 5/29/2024
Low VIX Index Most Often Seen During Bull Markets
Source: CW Advisors, Bloomberg, as of 5/29/2024
The bottom line is: while a high VIX is good, a low VIX is not bad at all! A low VIX should be embraced, not feared.
Sauro Locatelli CFA, FRM™, SCR™
Director of Quantitative Research
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