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S&P 500: Calm Before the Rally?

Published 23/01/2023, 07:26 pm

The marker is now in the heart of the corporate earnings reporting season. Traders will soon be digesting big tech’s fourth-quarter profits, as well as a Federal Reserve meeting and monthly jobs data. That’s a lot to take in. Volatility must be high with so much hanging on the line, right? Wrong.

The Volatility Index, or VIX, has dropped significantly, nearing levels last seen during 2021’s bull market. At less than 20, the VIX — known as Wall Street’s “fear gauge” — implies a somewhat tame 30-day S&P 500 price change of less than 6%. For perspective, the VIX spiked to almost 40 at various times last year, such as when Russia invaded Ukraine, during the June stock market low, and amid the market shakiness after the inflation report for September.

Closing out last week at 19.85, the VIX is smack-dab at the long-term average that’s been set over the 30 years since the Chicago Board Options Exchange first constructed the index. Investors should recognize that volatility — like individual stocks — swings back and forth between highs and lows. But while stock indexes rise over time, volatility is mean-reverting: The VIX often spikes quickly, then takes time to settle down.

What the VIX tells us right now is that, while Wall Street strategists are generally bearish on the market’s outlook over the next several months, major downside plunges are not as likely as they were in 2022. One volatility catalyst — the potential debt ceiling crisis — is currently an afterthought for traders. Anything can happen, of course. But I’m not expecting greater stock market turmoil driven by D.C.’s machinations, and VIX traders seem to agree.

A low VIX is not an all-clear, though. Sub-20 readings were seen last April, August, and early December. Each instance turned out to be a near-term high point for the S&P 500. If we get some upbeat news over the next few weeks, perhaps today’s somewhat muted VIX reading will stick — and stocks can rally further.

This article was first published on the Humble Dollar.

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