March 25, 2021 glacierinvest

Volatility is a measure of the dispersion of returns of an individual stock or market index. Higher volatility tends to be associated with riskier securities and/or environments. Academic studies have shown that prices and volatility tend to be negatively correlated. In other words, when volatility is rising prices are falling. It’s not quite that simple but suffice it to say that large, sudden moves in volatility higher generally result in falling stock prices.

The volatility index for the S&P 500 has been around for a little over 30 years. It represents the market’s expectations for movements in the S&P 500 index level based on S&P 500 index option activity and pricing. While complex, it has been a fairly reliable indicator of investor sentiment, fear and complacency, in particular. The VIX was under 20 for much of the past 10-12 years with occasional spikes higher. The general consensus is a VIX under 20 implies stable expectations. Fear is low and there may be some complacency. Spikes higher, particularly above 40, tend to imply fear among investors and negative expectations. Interestingly, peak negative expectations, as reflected in the VIX level, tend to coincide with market bottoms after vigorous sell-offs. An important lesson from this observation is selling at the point of maximum pain is almost always the worst possible selling decision you can make even though it relieves a lot of built up pressure.

Since hitting an all-time high in March of 2020, the VIX has been trending downward, although still elevated relative to the dominant trend of the past 10-12 years.

Regardless, stocks are still up year-to-date but market action has been choppy. Certain pockets (e.g., value) have performed noticeably better than other pockets (e.g., growth) of the market. There’s nothing to say the VIX has to fall below 20 again for the stock market to keep climbing higher. It might just be a different group of stocks that outperforms in a north of 20 VIX landscape.