The S&P 500 suffered a nine-day losing streak through the end of last week. The grind lower was rather orderly and resulted in just a 3.1% loss for the S&P 500. In fact, since September, the S&P 500’s average daily move has been roughly 7 points, well below the 12.9-point average daily moves seen in the first nine months of the year. Yet, although the recent action in the S&P 500 continues to lack conviction and daily swings haven’t been eye-popping, there has been notable movement in one key measure of market volatility.
VIX Roars Back to Life
The CBOE Volatility Index (VIX) reached multi-month highs last week. The market’s “fear gauge” finished Friday at 22.5, and that, in turn, represents the highest levels since the days just after the U.K. referendum to leave the EU, or “Brexit,” roiled financial markets in late June. Figure 1 shows VIX staging a nine-day winning streak and rallying to multi-month highs.
The rise in the VIX occurred amid a notable lack of actual volatility. While VIX is computed using pricing models and premiums on a strip of short-term options on the S&P 500 Index (SPX), 20-day historical volatility is a measure of volatility computed using closing prices over the past twenty days. On Thursday, the 20-day historical volatility of the SPX had dropped to less than 7% and two-month lows. The last time this measure was less than 7%, VIX was near 12, but last week it closed around 22.
Figure 2 shows the percentage difference between VIX and 20-day realized volatility. Notice the big spike in late-June amid increasing anxiety around the UK referendum. As the event passed, markets stabilized and the VIX fell, even dipping below 20-day HV. As the week ended, the divergence was notable once again and, with volatility more than 200% greater than actual volatility over the past twenty days, it was even more extreme than it was in late June.
Market moves are hard to predict. That’s because they’re typically driven by the collective decisions of millions of investors and there is no way to know what people will do next. Case in point: the “Brexit” decision sent such shock waves through global financial markets because the decision was unexpected. The kneejerk reaction proved short-lived, however, before a sense of normalcy returned this summer.
As the current trading week began Sunday, it appeared the market reaction would mirror that of “Brexit.” As the Federal Bureau of Investigation announced that no charges would result from its look into Democratic presidential candidate Hillary Clinton’s emails, bullish sentiment returned, with the SPX rallying 1.5% in pre-market trading. The VIX reacted strongly, falling over 15% before the market opened for the week.
Next week, after the market has had time to digest the election results, we may revisit the differential between VIX and actual volatility.
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