After last week's wild swings in U.S. stocks, the panic appears to have subsided, but if history is any guide, markets are likely to remain nervous in the coming months.
The CBOE Volatility Index (VIX), Wall Street's most closely watched fear gauge, quickly retreated after hitting a four-year high at the close last week, as stocks rebounded from their worst plunge of the year. The S&P 500 (SPX) is up 3% from last week's low, while the VIX is hovering around 20, well below its close of 38.57 on August 5.
Investors pointed to signs of quickly dissipating market anxiety as further evidence that last week’s crash was due to the liquidation of large leveraged positions, including carry trades funded in yen, rather than long-term concerns about global growth.
Even so, volatile periods when the VIX spikes suggest that markets tend to remain frothy in the months after a crash, refutating the kind of risk-taking that drove up asset prices in the first half of this year.
In fact, Reuters analysis shows it takes an average of 170 trading days for the VIX to revert to its long-term median of 17.6. A close above 35 is associated with high levels of investor anxiety.
“Once (VIX) settles into a range, people start to become more passive again,” said JJ Kinahan, CEO of IG North America and president of online broker Tastytrade. “But there’s usually a six to nine month window before people get nervous.”
Before this month’s turmoil in U.S. stocks, the S&P 500 had been in a long, quiet period, with a 19% gain this year and a record high in early July. Last month, disappointing earnings from several high-valued technology companies triggered a broad sell-off and pushed the VIX from just above 10.
More turmoil occurred in late July and early August when the Bank of Japan unexpectedly raised interest rates by 25 basis points, squeezing investors engaged in carry trades, where they borrow cheap yen to buy high-yielding assets such as U.S. technology stocks and bitcoin.
Meanwhile, investors have rushed to price in the possibility of a slowdown in the U.S. economy following a string of worrisome economic data. The S&P 500 has fallen as much as 8.5% from its July record high, just shy of the 10% threshold typically 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 decline and rapid rebound indicated a positioning-driven unwinding of risk exposure.
"What we saw last Monday was really confined to equity markets and foreign exchange markets," she said. "We didn't see a corresponding large increase in other asset classes, such as interest rate volatility and credit volatility."
Investors have good reason to remain nervous in the coming months. Many are awaiting more U.S. economic data, including a report on consumer prices later this week.
Uncertainties ranging from the U.S. election in November to tensions in the Middle East also kept investors on their toes.
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 gauge whether calm has truly returned to the market.
“Until the VIX drops below its long-term average of 19.5 (at least for a few days), we need to respect market uncertainty and humbly try to find a bottom in the market or in individual stocks,” he said.
The approach of the U.S. stock market to the correction range may be another concern. Data since 1929 shows that in the 28 cases where the S&P 500 index was less than 1.5% away from confirming a correction, the index finally confirmed the correction within an average of 26 trading days 20 times. In the 8 cases where the correction was not confirmed, the index took an average of 61 trading days to reach a new high.
Mark Hackett, Nationwide's chief investment research officer, said in a recent memo that CPI data due on Aug. 14 and earnings from Walmart and other retailers this week could be critical in determining investor sentiment.
"Given the heightened sentiment in markets recently, it's not surprising that this week's CPI data, retailer earnings and retail sales data could spark an exaggerated reaction from investors," he said.
The article is forwarded from: Jinshi Data
