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Dec 13, 2018

Wall Street's Fear Index Says This Is No Short-Term Selloff

By Mark Kolakowski Updated Dec 13, 2018



As measured by the CBOE Volatility Index (VIX), the level of fear among stock market investors is at its most sustained pitch in nearly three years, The Wall Street Journal reports. Specifically, the VIX has closed above a value of 15 on 46 consecutive trading days from Oct. 8 through Dec. 12, the longest such stretch since March 2016. By contrast, in 2017 the VIX closed above 15 on only five occasions, and spent most of the year in a range around 10.
“This shows that unlike October, investors no longer see the market correction as a temporary dislocation, but rather driven by more persistent macro risks,” as Mandy Xu, derivatives strategist at Credit Suisse, recently observed in a note to clients, as quoted by the Journal. Meanwhile, the Investopedia Anxiety Index, which measures our own readers' level of worry based on what they are reading, is registering high anxiety regarding the economy and the market.

Significance For Investors

"Looking at the world through the lens of volatility, we see markets that are unsustainably out of sync, fragile, and overall underpricing the risk of regime change," Benjamin Bowler, the head of global equity derivatives research at Bank of America Merrill Lynch, said in a note to clients, as reported by Business Insider. Give that the VIX often is interpreted as a barometer of fear and pessimism in the market, the rise in its value also is taken as a bearish signal by some market watchers.
Credit Suisse finds that recent pricing action in options linked to the S&P 500 Index (SPX) shows that traders are anticipating sustained levels of higher volatility in 2019, per the Journal. This is a turnaround from the past few months, when options traders were expecting spikes in volatility to be transitory. In fact, the so-called short vol trade, in which speculators bet on low volatility going forward, had made a recent comeback in popularity despite having blown up spectacularly earlier this year, as detailed in another Investopedia article.
Jeffrey Gundlach, founder of DoubleLine Capital LP, which has about $120 billion in assets under management (AUM), is bearish on U.S. stocks, U.S. corporate bonds, the U.S. economy and the U.S. dollar, per CNBC. "It certainly looks like the U.S. is going to break down to me and to a lower level," he said.
Gundlach sees a slowing economy and worries that the Federal Reserve is on a "suicide mission," by raising interest rates as the federal budget deficit explodes. "Corporate bonds remain very overvalued...corporate bonds should be avoided," he advises. He also believes that U.S. stocks are headed to their February lows, and are likely to break below that level. Given his forecast of a falling U.S. dollar, he thinks that equity investors "will do much better" with non-U.S. stocks.

Looking Ahead

The VIX offers a classic case of how different market watchers and investors can draw completely opposite conclusions from the same data. A high or rising VIX is a bearish signal to some, who see a loss in investor confidence. Others interpret it as sign of rising caution and prudence in the market, which will make gains more sustainable.
Likewise, a low or falling VIX is seen by some as a sign of irrational exuberance, or excessive risk-taking that ultimately will result in a crash. Meanwhile, others will see it as an indicator of investor confidence, and thus a bullish signal.
As of the close on Dec. 12, the S&P 500 is down by 9.8% from its all-time high set on Sept. 21. This represents a rather unremarkable correction, by historic standards. Meanwhile, noted investment strategist Jim Paulsen of The Leuthold Group sees volatility as a good thing, asserting that "in stable financial markets, stocks struggle," as a previous Investopedia article discussed.