All the worries about rising interest rates, a U.S. recession, the debt ceiling, and geopolitical turmoil have not caused the S&P 500 index and the SPY ETF to plunge. Since reaching a low in mid-October 2022, the leading stock market index has made higher lows and higher highs and is close to breaking out above the August 2022 technical resistance level.
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The VIX index measures the implied volatility of S&P 500 put and call options. The volatility measure rises during bearish periods and falls when the stock market moved to the upside.
In a May 25 Barchart article, I wrote, “ The bearish converse pattern of lower highs and lower lows in the VIX, with the index at 19.11 on May 25, not far above the most recent 15.53 low and far below the late September 2022 35.00 high.” Since then, the S&P 500 continued to make higher lows and higher highs, and the VIX dropped below the 14 level.
A bullish trend in stocks
The global pandemic caused the S&P 500 index to reach rock bottom in March 2020.
© Barchart
The chart shows the 120% rise from 2,191.86 in March 2020 to 4,818.82 in January 2022 as central bank liquidity and a tidal wave of government stimulus caused the leading stock market index to more than double in under two years. The index then ran into selling as the war between Russia and Ukraine broke out, and the U.S. central bank addressed inflationary pressures with the most aggressive credit tightening in decades. The index corrected 27.5% to a 3,491.58 low in October 2022.
© Barchart
The SPY ETF that tracks the S&P 500 rose from $218.26 in March 2020 to $479.98 in January 2022, or 120%, before falling 27.5% to $348.11 in October 2022 as SPY did a picture-perfect job tracking the S&P 500 index.
Since the October 2022 low, the index and its ETF product have made higher lows and higher highs, approaching technical resistance at 4,325.28 on the index and $431.73 on SPY. The index and ETF were within striking distance at 4,284 and $428.84 on June 7.
A bearish trend in the VIX
A bullish trend in the S&P 500 causes the demand for price insurance to protect long investment positions to decline. Since late 2022, the trend in the VIX has been lower.
© Barchart
The VIX index fell from 34.88 in late September when bearish sentiment and fear gripped the U.S. stock market to its most recent 13.95 low on June 6 and was sitting at just over the 14 level on June 7. The 13.95 low was the lowest level for the volatility index since February 2020, before the start of the global pandemic.
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Summer is a sleepy time in markets
The summer tends to be a quiet time in markets across all asset classes, and stocks are no exception. Liquidity often declines as investors, traders, and market participants take time off and enjoy the weather and school vacations.
The 2023 summer comes after the 2020 pandemic, the 2022 war in Ukraine, and most recently, geopolitical tensions and fears surrounding the U.S. debt ceiling, where the administration and Congress reached a last-minute compromise to avoid a default. It would not surprise anyone if the markets went into a coma through the Labor Day weekend in early September. However, when the markets expect low volatility, a sleepy period can create an environment where surprises hit market participants like a ton of bricks.
In a May 25 Barchart article, I suggested, “Fear and greed has not descended on Markets – Now is a great time to prepare.”
Geopolitics and U.S. domestic politics could roil markets
Even if markets remain quiet over the coming weeks and months, the geopolitical and economic landscapes remain a minefield of potential problems. The war in Ukraine appears to be escalating, with Russian President Putin’s grip on power at risk. Moreover, reports of his failing health could cause significant uncertainty in one of the world’s leading nuclear powers.
Meanwhile, the bifurcation of the nuclear powers, China’s plans for reunification with Taiwan, and nuclear proliferation in Iran and North Korea make the world increasingly dangerous. Any missteps can shock the world.
In the U.S., the 2024 Presidential campaign is gearing up with a slew of Republican candidates declaring their intentions to challenge former-President Trump, the current frontrunner for his party’s nomination. Low popularity ratings could increase challenges to President Biden over the coming weeks and months. Moreover, the potential for criminal indictments could throw the campaigns into a frenzy. The U.S. may have kicked the debt ceiling can down the road but funding an over $31.7 trillion deficit with the Fed Funds Rate at 5.125% costs more than $1.6 trillion annually.
Markets reflect the economic and political landscapes, which remain highly volatile in June 2023.
The VIX could be near a bottom, but it may remain under pressure for the coming months
The VIX at the 14 level is far too low, given the potential events circling markets. The downside risk is low, and the upside potential could be explosive. A quiet summer would likely keep pressure on the volatility index, but any sudden surprises could ignite the VIX, causing it to explode higher in the blink of an eye.
I would only trade the VIX from the long side at the current level and happily accept short-term losses in the quest for substantial profits.
The stock market and S&P 500 remain in a bullish trend in early June 2023, but the potential for events that could derail the rally is a clear and present danger. The summer may be sleepy for markets, but risk-reward continues to favor surprises and a rally in the VIX.
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On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.