Seeing the US Markets through VIX glasses: volatility insights for the Smart Investor

1. Spike in Early 2018:

   Marked by a significant increase in volatility, this period was characterized by market turbulence due to concerns over inflation and rising interest rates.
    

2. Peak during the COVID-19 Pandemic:

   The VIX reached unprecedented levels as the pandemic induced extreme uncertainty and market panic, highlighting the VIX’s role as a fear gauge.
 

3. Post-Pandemic Volatility:

   The period following the initial pandemic shock saw fluctuating volatility levels as markets adjusted to ongoing uncertainties related to economic recovery, monetary policies, and geopolitical events.  

Currently, the VIX is at a lower level compared to these past spikes, indicating a period of relative calm. However, the historical pattern suggests that sudden increases in volatility can occur, often triggered by unexpected events.

Key volatility indicators

• VIX index: The current VIX level is 13.44, indicating moderate market volatility, with a net increase of 0.32 points or 2.44%.
• VIX futures:
• Jul 2024: 13.34 (+0.20, +1.55%)
• Aug 2024: 14.25 (+0.03, +0.22%)
• Sep 2024: 15.31 (+0.09, +0.66%)
• Oct 2024: 17.55 (-0.10, -0.55%)
• Nov 2024: 17.35 (-0.05, -0.29%)
• Dec 2024: 16.90 (-0.15, -0.88%)
• Jan 2025: 17.50 (-0.10, -0.57%)
• Feb 2025: 17.90 (-0.07, -0.42%)

Current market analysis

• VIX trends: The VIX index is at 13.44, reflecting a moderate level of market volatility. The increase suggests a growing, but still moderate, concern among investors.
• VIX futures curve: The futures prices show significant jumps in volatility for October and December 2024, indicating expected higher volatility in these months. The October futures, which cover November, reflect uncertainty around the US elections. Similarly, the spike in December futures likely reflects concerns related to potential disruptions of the certification of the presidential election results in early January 2025, following the violent attack on the certification of the 2020 election results in January 2021.

Additional indicators

• VVIX (Volatility of VIX): Currently at 83.86, up 2.25 points or 2.76%, indicating increased volatility in the VIX itself. The VVIX, also known as the Volatility of the Volatility Index, measures the expected volatility of the VIX. A higher VVIX suggests that there is a greater level of uncertainty or risk regarding future volatility. This can indicate that market participants are anticipating significant swings in volatility, which can lead to increased market unpredictability. Current VVIX values are historically on the lower end, VVIX values can easily go above 100, at which it is often perceived as high.
   
• SKEW (Cboe Skew Index): At 147.40, down 3.46 points or 2.29%, suggesting a lower perceived risk of extreme market moves. The SKEW index measures the perceived tail risk of the distribution of S&P 500 returns. It indicates the probability of outlier returns, or significant deviations from the average. A higher SKEW value suggests that investors are paying more for protection against extreme negative market events, implying higher perceived risk of a significant market move. Conversely, a lower SKEW indicates that the perceived risk of such extreme events is lower. SKEW values above 150 are usually considered high.
   
• COR3M (Cboe Implied Correlation Index): At 8.65, up 0.85 points or 10.90%, indicating higher correlation among S&P 500 stocks over the next three months. The provided chart shows a recent upward trend from 7.8. However, it is important to note that COR3M is at multi-year lows, indicating that individual stocks are not moving as much in sync as they have in the past. While this low correlation might suggest opportunities in stock selection, it also makes it increasingly difficult to pinpoint the good ones. In such an environment, diversification often becomes the best course of action to mitigate risks and capture potential returns.
   
• DSPX (Cboe Dispersion Index): At 34.24, up 0.29 points or 0.85%, reflecting the cost of options hedging against S&P 500 movements. The provided chart shows a significant increase, indicating rising costs for protection against market moves. The DSPX is at high levels, which means that the dispersion or the difference in returns between individual stocks in the S&P 500 is increasing. While high dispersion often signals greater opportunities for active management and stock-picking strategies, it also makes stock-picking far more difficult. In this case, diversification becomes a more logical choice to balance potential returns with risk management.

Interpretation and future scenarios

• Market sentiment: The current levels of VIX, VVIX, and other indicators suggest a market with moderate current volatility but potential for increased volatility in the near term.
   
• Potential scenarios:

  • Low volatility scenario: If the VIX remains low and steady, it indicates a stable market environment. This would typically mean that investor confidence is high, and there are no significant economic or geopolitical risks on the horizon. In such a scenario, the market is likely to experience steady, gradual gains. Defensive stocks and bonds might underperform, while equities and riskier assets could see consistent growth.

  • Moderate volatility increase: A gradual rise in volatility, as indicated by the near-term futures, suggests that the market is becoming more uncertain. This could be due to upcoming economic data releases, earnings reports, or geopolitical events. In this scenario, investors might see more market fluctuations but no drastic declines or spikes. Portfolio diversification and balanced investment strategies would be key to navigating these conditions, potentially focusing on sectors that benefit from moderate volatility, such as consumer staples or utilities.

  • High volatility spike: If unexpected events cause sudden increases in the VIX, diverging from current futures expectations, this would indicate a market in turmoil. Such events could include significant geopolitical conflicts, major economic policy changes, or unexpected economic downturns. In this high-volatility scenario, the market could experience sharp declines and increased uncertainty. Investors would need to focus on risk management strategies, such as increased hedging through options, moving to safe-haven assets like gold and government bonds, and reducing exposure to highly volatile stocks.

  These scenarios provide a framework for understanding how different levels of volatility can impact market dynamics and investor strategies. By anticipating these potential outcomes, investors can better prepare and adjust their portfolios to mitigate risks and capitalize on opportunities.

Conclusion

The VIX and its related indicators suggest a currently calm market with expectations of rising volatility in the near term. Investors should remain vigilant, employ risk management strategies, and be prepared for potential volatility increases.

By leveraging these insights, smart investors can better navigate market conditions and make informed decisions.