He’s talking about the VIX, or the CBOE Volatility index. It is quoted in percentage points and measures the expected movement in the S&P 500 index over the next 30-day period, which is then annualised.
The S&P 500 is the world’s most watched stock market index. A climbing VIX means that American, and also global, investors are becoming more fretful. Their selling drives the stock market down. The higher the VIX rises, the bigger the crescendo of concern.
The flipside is that the lower the VIX drops, the more the S&P 500 climbs. That’s when investors start to become complacent and the risk of a big sell-off rises as the supply of buyers runs out.
What the VIX is telling us now
Right now investors are becoming dangerously complacent. Analysts have been growing very bullish about official stats. Optimism has spread about the global economy. And all that despite Chinese growth slowing and the eurozone, which is still coping with major debt problems, facing a return to recession.
In fact, fund managers have been ploughing clients’ cash into shares faster than at any time since early-2011. And ‘short interest’ – where traders sell in the hope of buying back lower down – is at its lowest point for four years. All these are signs of fast-falling fear levels in stock markets.
But before we all buy into this bullish bonhomie, let's pause a moment. It's worth looking at what happens when the price of volatility becomes so cheap. And not just in the US. The overall performance of London–listed shares is closely linked to Wall Street. In other words, the VIX is a handy guide to the FTSE 100 too, as this chart shows.
Source: Bloomberg, FSL
You can see how the VIX (the red line) has plunged over the last six months. The FTSE 100 has been a near-mirror image of this. But since the financial crisis began in 2007, such low points in the fear gauge have always been followed by a sharp downswing in the equity market.
OK, this hasn’t always happened straightaway. And current investor complacency might yet take a few more weeks to shatter. There has to be a catalyst, and right now it’s unclear what that will be. But in summary, today’s overall market levels are looking increasingly dangerous.
David Stephenson
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ReplyDeleteThanks Bigshot. Keep in touch and i will try to bring you the most relevant news and stats from the best economists.
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