While most investors follow the movement of the Dow Jones Industrial Average (DJIA), S&P 500 and the Nasdaq, a little know indicator called the VIX has been getting a lot of attention lately. The VIX or the volatility index, also known as the fear index, measures the implied volatility of options on the S&P 500. A low VIX signals confidence about the stability in markets while a high VIX suggests that protection of portfolio positions may be required. Geopolitical concerns and unexpected events such as Brexit, Trump Win etc. tends to drive up the VIX reading while strong economic data, good earnings reports from companies in the S&P 500 etc. lowers the VIX numbers.
The VIX is typically event driven – best example of this is the VIX price reaction to the US election when the volatility index moved higher by 50% from the accepted average value of 16. Since then, the VIX has been trading at historical lows around 12, indicating the market is not expecting major event in the near future. In Q1 2017, low volatility was a persistent trend, trading in a range from 10.6 and 13.1.
But things have changed over the past few weeks and the VIX has moved back up to 15.50. There could be several reasons – French elections, US led air strike on Syria and tension around North Korea among others.The rising trend in the VIX has prompted the recent pullback in the stock market over the past few weeks. Money is now flowing out of equities and back into bonds and safe haven assets such as gold, as increasingly the sense is that the stock market has run up too high, too fast and is primed for a correction.
Future Wealth’s View
While we, at Future Wealth, concur that after the recent runup in the S&P 500, Nasdaq and DJIA, a correction to bring valuations down to more modest levels would be a healthy one, we do not believe that a rising VIX is a good predictor of an imminent correction. The VIX is primarily driven by random events and it is unwise, in our view, to be shuffling one’s portfolio positions based on a higher VIX indication.
With Q1 2017 earnings coming out starting this week, we would paying more attention to the results from the major banks, tech and healthcare companies to get a sense of where the economy is headed. If earnings growth and outlook from the S&P 500 companies remains bullish, we would expect the VIX to come back down from current levels.
On the other hand, if geopolitical events were to go into crisis mode with Russia, Syria or North Korea, good earnings season could be swept under the rug and the VIX will continue to climb to higher levels shaking up the equity markets.
With appropriate safety measures, our client portfolios remain unchanged despite a rising VIX. We see little reason to be heading to the exits at this time, unless we end up being dragged out by United Airlines.