Does history repeat itself? That seems to be the case with the CBOE VIX index.
The VIX which measures market volatility of the S&P 500 has gone past the ‘historic floor’ marker following a series of events that resulted in high market tranquility. VIX rates have been hovering between 9 and 10 in the past few days indicating its lowest closing levels since the 1990s. Recorded rates included a 9.84 and even a 9.72.
The Financial Times reported that the results of the French election brought indices to its current rates and mentioned that the European market has been experiencing the same. European equities faced losses as investors were hung up evaluating situations over speculations of Macron’s victory following the first round of voting last month. As a result, most European stock gauges plunged.
The good news for US investors is that local equities proved to be unaffected even though the VIX experienced a historic decline. Bloomberg shared market data showing that the S&P 500 achieved its third weekly gain and projections even point to a raise in interest rates from the Federal Reserve next month.
If that’s the case, then what does low VIX levels actually mean for the stock market?
Looking at the bigger picture, Schaeffer’s Investment Research explained that valuations remain high. This is an indicator that the performance of the stock market will be good long-term. Profit margins of S&P 500 companies are beating expectations and estimations for the remainder of the fiscal year lean on the positive side.
However, this does not accurately reflect the short-term periods. That’s where measurement tools like the VIX come in. The VIX looks at projections of the market’s performance within the next 90 days and for short-term traders, low levels are almost usually a cause for concern. Stock trading company Teramusu specified that major indices such as the S&P 500 are benchmarks of global markets and leading stocks values shift constantly which creates opportunities for profit. But when the market is tranquil, these opportunities decline in proportion to the decreasing rates of measurement gauges. This is why the VIX is also known as the ‘fear gauge’.
Nevertheless, using comparisons with previous incidences of VIX plunges, it was observed that the underperformance doesn’t last. There were usually low returns over the following week up to the three-month marker, but the market flipped back to positive levels around 80% within six months. One year later, the performance returned to 100% which was before the decline.
Hence, low VIX rates don’t necessarily mean a major dive in the stock market. There may be a high tendency to have poor returns within the coming weeks, but as active as the stock market is today, you can expect that it will bounce back as it always does.