A month ago, when the U.S. stock market was still reeling from its fastest collapse in history, BTIG Chief Equity and Derivatives Strategist Julian Emanuel gave some investors some prescient advice.
He told them to watch the market’s “fear gauge” for clues about whether the fledgling rebound was the beginning of a genuine recovery or just a bear market rally.
Although the Dow and S&P 500 had already rocketed off their March 23 lows, Emanuel warned that the CBOE Volatility Index (VIX) “remained stubbornly elevated” above its historical average.
The VIX, a measure of implied volatility in the S&P 500, had surged to a record high of 85.47 after ranging in the low teens throughout January and February. Any reading above 20 is typically considered an indication of market turmoil.
When Emanuel published his note on March 29, its most recent close was 65.54 – hardly a sign that the stock market was out of the woods.
True bull markets tend to be low volatility and uncorrelated — December and January seem so long ago.
Emanuel suggested investors should remain extraordinarily cautious until the VIX had receded below 50 and – more importantly – stayed there.
The VIX ended the session beneath 50 on April 3, and it hasn’t looked back. The “fear gauge” has closed below 50 for 17 consecutive trading days. At last check, the VIX was holding near 34 on Thursday.
That in itself is a bullish sign for the stock market. If Emanuel is correct, it could mean that the Dow really did bottom on March 23 and that this isn’t – as Bianco Research president Jim Bianco warns – a bear market rally. But it’s not the only positive sign investors can glean from watching the VIX.
Just this week, the VIX flashed another bullish indicator.
It closed below its second-month future on April 27, something it hadn’t done since February 21 – just two days after the S&P 500 recorded its all-time high. This is an encouraging sign.
As Bloomberg explains, VIX contracts with later expiration dates trade higher under ordinary market conditions for the simple reason that they carry more uncertainty.
The coronavirus pandemic upended that market structure and caused the VIX to hold above its second-month future pricing for more than two months. So it makes sense that a marked decline in uncertainty about the coronavirus outbreak has correlated with a drop-off in market stress.
This chart from Deutsche Bank Research shows a remarkable correlation between the VIX and the number of countries with daily coronavirus case rate growth of 5% or more.
With the pandemic clearly on a downslope, that’s thoroughly good news.
But for a stock market that’s firmly in recovery mode, it also presents a threat that scientists warn isn’t likely to go away anytime soon: a potential second wave of COVID-19.
Disclaimer: The opinions in this article do not represent investment or trading advice from CCN.com. Unless otherwise noted, the author has no position in any of the stocks mentioned.