It’s been a loud 7 ½ months. In fact, it’s been a pretty loud last 12 months. With so much noise infiltrating screens and airwaves, it’s increasingly tough for an investor to sort out what’s signal and what’s nonsense. Maybe the best illustration of how much noise (or lack thereof) there’s been recently is the CBOE Volatility Index (VIX). What’s been the loudest variable investors have been forced to deal with this year has suddenly gone quiet. And the silence is deafening.
The VIX closed below 20 last week for the first time since April, ending a streak of 86 trading days above the long-term average of 20[1]. Why’s that matter? Well, when you pair the VIX with the price action of equities, you can see quite clearly the inverse relationship between the two. See the below mirror image of the S&P 500 (top panel) and the VIX (middle panel), paired with the AAII Bullish Sentiment Survey reaching the highest level since March of this year (bottom panel):
Even if just for a breather, peaks in the VIX have coincided with troughs in equities, and vice versa. This is behavior that is pretty consistent over longer-term time horizons as well.
So, does this visit below 20 for the VIX mean a new bull market has begun? Maybe, maybe not.
There have been long VIX streaks above 20 in prior bear markets that ended only to be followed by lower lows ahead (ex: Jun ’00, Jun ’01, Feb ’02, Apr ’08, Aug ’08). Check out the table below:
Why the sudden change in heart in the market?
We don’t think we’ve seen much materially change from the headwinds that have been facing the market since the start of the year. But what we have seen in the last 6 weeks has been an improvement in market breadth[4], a firmer stance to fight inflation from the Fed, the worst (so far) recession odds being priced into the market[5], and the apparent peak in headline CPI/PCE[6]. We think a reprieve in these elements in the near-term are viable reasons as to how you see a 50% retracement from the recent (June) lows. But retracements don’t necessarily proceed without resistance.
So, what are investors supposed to make of this sudden change in environment? Has risk left the chat? Likely not. We suspect it’s just turned its phone to do not disturb while on holiday in Jackson Hole.
Volatility, as measured by the VIX, is nothing more than a personification of our own anxieties. Unfortunately for the lot of us, most people haven’t spent adequate time working on enhancing their emotional intelligence. For those of us looking for the cliff notes, the short of it is, emotions, especially anxiety, tend to come in waves. In periods of heightened sensitivity, these waves might seem to be arriving in quicker intervals. When this happens, a crescendo effect unfolds, and we can ultimately find ourselves in some sort of spiral.
This is comparable to how sound waves behave in physics. Waves are triggered and the initial oscillation of the waves is short in duration, eventually fading. This is because the waves themselves (like emotions) aren’t self-sustaining.
We slowly can process our anxiety about something potentially happening in the future (i.e., a recession) and eventually, our heightened level of concern will subside, absent of any new concerns or evidence of our fears being valid. Like pressing a key on a piano. One firm finger might ignite a powerful cord. But eventually the vibration dies, and the next note is needed before anybody confuses you with Billy Joel.
Volatility is much like the sounds waves in the example above. As a whole, we market participants seemed to lose a grasp of our anxiety in the first 6 months of the year. One concerned piled on top of another, and the narrative we collectively spun was that doom was imminent. This is illustrated by the VIX registering a reading of at least 26 (1 standard deviation above its long-term mean) in 56% of all trading days this year[7]. The waves have begun to spread apart. Anxieties have seemed to cool. It may not be coincidence that we’ve hit a quiet period with the Federal Reserve not having a meeting in August. It’s been one less (and just so happens to be the biggest of 2022) talking point for the last 30 days. However, we’d encourage investors to not cancel their next few sessions with their therapists. Because the next few months might get loud.
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[1] Data provided by Bloomberg database.
[2] Chart provided by Bloomberg database.
[3] Charlie Bilello, Compound.
[4] 48% of S&P 500 constituents are trading above their 200 DMA vs 13% in June, as of 8/16/2022. Data provided by Bloomberg database.
[5] CDX pricing peaked as of July 29, 2022, data provided by Bloomberg database.
[6] BLS, July 29, 2022.
[7] Data provided by Bloomberg database, through 8/16/2022.