Wall Street’s “fear gauge” has fallen to its lowest level in more than three years as the S&P 500 index looks poised to break out of bear-market territory.
The CBOE Volatility Index
VIX,
-6.71%,
often referred to as simply the “Vix,” closed at 14.47 on Friday after falling 7.5%, marking its lowest finish since Feb. 19, 2020, according to Dow Jones Market Data.
At the same time, the S&P 500
SPX,
+1.45%
notched a fresh 10-month high as the large-cap gauge looked set to exit bear-market territory, having risen nearly 20% from its closing low of 3,577.03 reached on Oct. 12, according to FactSet data.
Sam Stovall, chief market strategist CFRA Research, credited Friday’s blockbuster U.S. jobs data for May for helping drive markets higher, saying its the latest evidence that the recession that was widely anticipated isn’t on the horizon.
Stovall and Craig Johnson, chief market technician at Piper Sandler Technical Research, told MarketWatch that new lows for the Vix suggest that “FOMO” — that is, “fear of missing out” — is beginning to draw more investors back into the market as traders attempt to chase the rally in stocks.
See: Wall Street’s bearishness may offer another reason to buy, says BofA, as stocks rally
Whether or not investors keep piling money into the stock market remains to be seen, but there’s plenty more “dry powder” available to help drive stocks even higher, Johnson said.
He cited the roughly $4.7 trillion in cash stashed away in money-market funds, a figure that is more than $1 trillion higher than before the arrival of COVID-19, as one example.
This reservoir of capital could soon be put to work in the market, Stovall and Johnson said, if investors feel they’re missing out after what has been a strong rebound year for stocks after the losses of 2022, which were the worst since 2008. The S&P 500 is up 11.5% so far in 2023, with the Nasdaq up 26.5%.
Meanwhile, positioning data from the Commodity Futures Trading Commission show speculators remain decidedly bearish on the market. If they capitulate, it could help push stocks even higher, as positioning tends to be a counter-indicator for stocks, he said.
“Traders are thinking this market is coming in, but it’s not,” Johnson told MarketWatch during a phone interview. “With so much money on the sidelines, it’s hard to be pessimistic.”
A low Vix is generally considered a counter-indicator as well, but there have been plenty of times where the S&P 500 was higher one year later after the Vix was trading at 15 or below.
Below that, the outlook based on historical performance becomes more grim.
For example, during the summer of 2017, the Vix broke below 10 to fall to its lowest levels on record since its creation in the early 1990s as stocks drifted listlessly higher that summer, according to FactSet data.
But on Feb. 5, 2018, the short-volatility trade suddenly imploded, provoking what market strategists called “volmageddon.”
By the time the dust had settled, the Dow had logged one of its biggest selloffs in recent memory, and Credit Suisse said it would end trading in the VelocityShares Daily Inverse VIX Short-Term exchange-traded note, which used the ticker “XIV,” or “Vix” backwards.
The note had become a popular vehicle for the short-volatility trade, which had previously generated consistent profits. Ultimately, the S&P 500 finished 2018 with a loss of more than 6%, according to FactSet data.
There are also plenty of examples where stocks traded higher one year after the Vix hit 15 or below, including in 2005 and 2012, per FactSet.
Although it tends to move in the opposite direction of the S&P 500 on a daily basis — but not always — the level of the index is actually determined using demand for put and call options tied to the S&P 500.
More demand for options on the S&P 500, especially put options, which represent bets that stocks will fall, tends to push the Vix higher. Typically, demand for options intensifies when traders have something to hedge against, said Danny Kirsch, head of the options desk at Piper Sandler & Co. during a phone interview with MarketWatch.
That the Vix has moved lower is hardly a surprise now that the U.S. debt-ceiling has been raised and the Federal Reserve has signaled it likely won’t raise interest rates again until at least July, Kirsch said.
“The only big macro catalyst ahead is CPI and a bunch of central bank meetings in two weeks,” Kirsch said. “After that, you’re staring at two holidays, Juneteenth and the Fourth of July.”
Ultimately whether or not the 2023 rally continues will depend on the state of the labor market, economy and the Fed, Stovall said.
“With so much money on the sidelines its hard to be pessimistic,” Stovall said. “If this is a new bull market, it could end up lasting longer than people think.”
On Friday the S&P 500 rose 61.35 points, or 1.5%, to finish at 4,282.37, its highest closing level since Aug. 16, 2022. The Dow Jones Industrial Average
DJIA,
+2.12%
rose 701.19 points, or 2.1%, to 33,762.76, its biggest one-day point gain since January. The Nasdaq Composite
COMP,
+1.07%,
which has recorded the biggest year-to-date gain of the three indexes, was up 139.78 points, or 1.1%, to 13,240.77.