The panic appears to have dissipated after last week’s spike in volatility in US stocks, but if history is any guide, markets could remain in the low for months.
The Cboe Volatility Index, Wall Street’s closest gauge of investor anxiety, eased quickly after hitting a four-year high last week, and stocks rallied after their worst fall of the year. The S&P 500 is up 3% from last week’s low, and the VIX index is hovering around 20, well below the 38.57 level reached on August 5.
Investors pointed to a quick fading of market concerns as further evidence that last week’s unwinding of huge leveraged positions, including yen-financed carry trades, eased rather than longer-term concerns such as growth global.
However, the volatility in which the VIX soared shows that markets tend to remain in turmoil for months after a boom, countering the kind of risk that drove asset prices higher in the first part of the year. Indeed, Reuters analysis showed that the VIX took an average of 170 sessions to return to its long-term average of 17.6 after closing above 35, a level associated with high investor concern.
“When the VIX stabilizes in a range, people will be a little more passive again,” said JJ Kinahan, CEO of IG North America and president of online broker Tastytrade. “But for six or nine months, it usually shakes people up.
The US stock market turmoil this month follows a long period of calm in which the S&P 500 rose 19% for the year to hit an all-time high in early July. Cracks triggered by disappointing earnings from several popular technology companies sparked a massive sell-off last month and pushed the VIX out of its roughly 10% range.
More serious disturbances followed in late July and early August. The Bank of Japan unexpectedly raised interest rates by 25 basis points, effectively disrupting carry trade that prompted traders to borrow cheaply in Japanese yen to buy higher-yielding assets, from U.S. technology stocks United to bitcoin.
At the same time, investors were quick to assess the risk of a slowdown in the US economy after a series of alarming economic data. The S&P 500 index has lost as much as 8.5% since its July highs, falling short of the 10% threshold considered a correction. The index is still up 12% this year.
Mandy Xu, head of derivatives market intelligence at Cboe Global Markets, said the market’s rapid fall and rebound reflected a shift away from positional risk.
“What we saw on Monday (August 5) was really isolated to the equity market and the foreign exchange market. We didn’t see a corresponding increase in volatility in other asset classes, such as rate volatility and credit volatility,” she said. . .
Investors have plenty of reasons to remain nervous in the coming months. Many are awaiting US data, including the consumer price report later this week, to see if the economy is shifting into high gear or heading for a more serious slowdown.
Political uncertainty, from the US election in November to the prospect of heightened tensions in the Middle East, is also keeping investors on edge.
Nicholas Colas, co-founder of DataTrek Research, is watching to see if the VIX can stay below its long-term average of 19.5 to determine if calm is really returning to the markets.
“Until it (the VIX) goes below 19.5 (the long-term average) for at least a few days, we have to respect the uncertainty of the market and stay humble before trying to beat the market or the individual stock to find,” he said.
FIX TO SEE?
Another concern could be that the market has come close to the correction zone. Of the 28 instances in which the S&P 500 Index was within 1.5% of confirming a correction, it did so in 20 instances over an average of 26 trading sessions, according to data going back to 1929.
On the other hand, in the eight cases where it did not confirm a correction, the index took an average of 61 sessions to reach a new high.
CPI data due Aug. 14 and earnings from Walmart and other retailers this week could be key to investor sentiment, Mark Hackett, head of investment research at Nationwide, said in a recent note.
“It is not surprising to see potentially exaggerated reactions to this week’s CPI numbers, retail earnings and retail sales from investors, given the heightened emotional reactions in the market recently.”