Investment professionals usually talk about the VIX index as a ‘fear gauge’. That is due to the fact that volatility picks up during bear markets, and that is what the VIX really measures; volatility in the S&P 500. Rising volatility is a feature of bear markets until the S&P experiences extreme volatility, which is a signal of major bear market bottoms. Quite interestingly though the opposite is not the same, to some degree. Low volatility is not a reason to expect a major top to form but is a characteristic of bull markets. I believe one of the best uses for low volatility is as a confirmation of a bull market trend.
In the chart below you have the VIX in red on top and the S&P 500 in black on the bottom -going back to 1994. Nothing scientific here but in the blue boxes you can see that periods of low volatility tend to coincide with the meat of bull markets, with the one exception being the high volatility bubble in the late 1990s.
Source: Stockcharts.com, as of 12/13/2023
The interesting thing right now is that the VIX just hit 12, which is a very low VIX reading, for the first time in 3 years. Are we just getting confirmation that we are entering the meat of bull market that started in October 2022? Sauro and I decided to put some real numbers behind this and to no surprise they confirmed exactly what we would expect. When the VIX hits 12 for the first time in a year, and for as long as it stays below 25, forward 12-month returns are very strong. This occurs 32% of the time with a forward return of 14.3% compared to 6.9% otherwise.
Source: Congress Wealth Management, Bloomberg, as of 12/13/2023
Low volatility is here. Investors should embrace low volatility, not ‘fear’ it.
Sean Dillon, CMT, CFTe
SVP, Investment Strategy
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