The Market’s “Fear Gauge” Is Flashing Warning Signs For The Market – Here’s What You Need To Know

The Volatility Index and stocks are sending two very different messages. 

Evercore ISI strategist Dennis DeBusschere recently dubbed the market as “violently flat,” and it’s no wonder why.

The coronavirus pandemic, amid which the U.S. has seen cases rise to more than 3 million, has caused market turbulence, with fear rife across volatility markets even as stocks rise higher.

While the S&P 500 has rallied nearly 41% since the March 23 bottom, the Cboe Volatility Index—also known as the VIX, or the market’s “fear gauge”—remains roughly double its February low. 

The VIX ended Thursday at 29.26, just a bit elevated from Monday’s reading of 27.94. While that’s a far cry from the 80+ readings from mid-March, it’s still well above the 13 measure from mid-February before the coronavirus began to spread rapidly in the U.S.

Systematic traders who make a living by wagering on impending price gyrations are currently in a bit of a bind. On the one hand, a flat but elevated VIX futures curve is a warning sign for the pandemic-driven economic trajectory, the U.S. presidential election in November, and liquidity threats. But on the other hand, S&P bulls betting on policy stimulus see good reason to defy the flashing warning signs from the VIX. 

In other words, volatility traders currently lack the conviction to go all-in one way or the other as the VIX sends one signal on the risk in the market, and stocks send a different message. 

“Equity and equity volatility markets are pointing in very different directions,” said Societe Generale SA strategists in a note. “This dichotomy represents a serious issue for volatility market participants.”

Generally, when stocks climb higher, the VIX falls as traders turn optimistic on less turbulence down the road, while when stocks fall the VIX rises higher as fear takes over. But right now, Goldman Sachs and other big names on Wall Street say the gap between the “fear gauge” and the S&P 500 is one of the largest on record, thanks in part to the index’s rapid rise higher since the market bottom.

But even as stocks have risen higher, uneasiness never really left the market amid fears of rising coronavirus cases, mixed economic data, the possible end of fiscal aid, and the limits of monetary stimulus.

And given the current environment, it’s “tough to find strong conviction on buying or selling equity vol either way,” said Cohalo managing principal, Colton Loder, who added that the VIX could fall a bit.

Should the VIX fall to 26, it would be “huge for risk and a break below that level will unlock the door to 3,500 on the S&P,” said Evercore ISI technical strategist Rick Ross in a note. 

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