Jun 09, 2014 | by Franck Cushner, CFP®
Volatility in the stock market as represented by the Chicago Board S&P 500 Options Exchange Volatility index (VIX) reached a 5-year low in May. The lows in the VIX indicate a level of complacency or tranquility as it portends to equity investing but analysts are divided on the implication of such a downward move. Some feel this means a substantial amount of risk has come out of the market indicating smooth sailing and positive returns are ahead of us. Others feel this is a contrary indicator and trouble lies ahead as risk is usually evident when it is least visible.
In the first camp, investors seemed to have shrugged off Russian and Central European military tensions, the possibility of a significant Chinese economic slowdown, and anemic U.S. economic growth rates. Those in the second camp feel that the potential negative effects of the Fed tapering its quantitative easing program as well as the still present risks mentioned above are not being priced into the overall stock market risk at this time.
The VIX index is basically an annualized prediction of short-term price volatility for the S&P 500 index over the forthcoming 30-day time period. So the index is essentially telling us that three months out, investors are not really expecting any major market shocks such as a significant market decline. However in the past, these low levels of volatility expectations have often predicted market turmoil as investor complacency sometimes ignores obvious risks. In February 2007, the VIX was at levels that we currently see today and during the financial crisis in 2008, the VIX increased over 600% at the peak of the stock market downturn.
Sources: S&P, Bloomberg, Reuters
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