Dow Jones Industrial Average (DJIA) futures enjoyed a relief rally on Thursday after a brutal two-day selloff saw 800 points wiped off the US stock market index.
But the pain might not be over yet. A broad measure of stock market volatility – the Cboe volatility index (VIX) – is still a long way from panic mode. Sitting at 20.03, the index is still in a relatively comfortable zone. In moments of real panic, the index peaks closer to 30. And in the last recession it hit 60.
After two days of brutal selling, Dow Jones Industrial Average (DJIA) futures bounced as much as 100 points higher on Thursday before settling lower.
Despite an 800 point wipeout in two days, we still haven’t seen true panic in the market.
The VIX tracks the market’s expectation of volatility, making it a useful indicator of fear and risk in the stock market. A reading below 12 is considered low risk, while a reading above 20 indicates fear creeping into trader sentiment.
At 20.03, the VIX is at the high-end of normal but a long way from crisis levels. In moments of real panic-selling, the VIX would leap higher towards a reading of 30. We saw this play out in December 2018 when the Dow chalked up a number of 400 point daily losses.
During the 2008 financial crisis, the VIX hit 60.
If the growing number of doomsday predictions are correct, the US could be heading for a recession in the coming 18 months. And if that plays out, a wave of panic selling will undoubtedly kick in.
Add to that a tsunami of potential stock market catalysts: trade war escalation, weak economic data in the US, UK, Germany, and China, a fresh round of weak corporate earnings, Brexit, the 2020 presidential elections.
There are plenty of events that could trigger panic selling and volatility in the coming two years.
Much of the panic selling could come from the trillions of dollar now parked in exchange-traded funds. Michael Burry, who famously predicted and profited from the 2008 crisis, says ETFs are the new stock market bubble.
“This is very much like the bubble in synthetic asset-backed CDOs before the Great Financial Crisis in that price-setting in that market was not done by fundamental security-level analysis.”
With half of all stock allocations now in passive funds, a selloff won’t just take down individual stocks, it will take down the whole market as one.
“Like most bubbles, the longer it goes on, the worse the crash will be.”
This article was edited by Samburaj Das.
Last modified (UTC): October 3, 2019 11:23