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The Stock Market ‘Fear Gauge’ Is Flashing All Kinds of Bullish Signals

Last Updated September 23, 2020 1:54 PM
Josiah Wilmoth
Last Updated September 23, 2020 1:54 PM
  • The CBOE VIX has closed below a crucial level for 17 straight trading days.
  • The stock market’s “fear gauge” is also returning toward an “ordinary” market structure after two months of turmoil.
  • Given the VIX’s correlation to coronavirus case rates, this is another bullish indicator for the stock market.

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.

Why the Stock Market’ Fear Gauge’ Is Suddenly Looking Bullish

CBOE VIX, stock market
Though not yet back in pre-pandemic territory, the stock market’s so-called “fear gauge” has closed below a crucial level for nearly 20 straight days. | Source: Yahoo Finance 

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.

And that’s exactly what he told his clients: 

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.

stock market chart, S&P 500 vs. VIX over time
The VIX (blue) tends to trade inversely to the S&P 500 (black). | Source: Yahoo Finance 

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.

Coronavirus Case Drop-Off Explains VIX Tranquility

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.

CBOE VIX, stock market
Movements in the VIX suggest the stock market is returning toward a more typical structure. | Source: Bloomberg 

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.

how coronavirus affected stock market
Source: Twitter 

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.