Four largely unnoticed market indicators suggest that major turmoil is ahead even as stocks have risen to a series of new all-time highs in seemingly orderly fashion. “Since 2007, no other time has seen all four of them so compressed at the same time,” observes Jason Goepfert, the president of Sundial Capital Research, in a note to clients cited in detailed report by Business Insider that is summarized below.
The four gauges essentially analyze investor sentiment and risk. When all four indicators are simultaneously near the bottoms of their one-year ranges, as they are now, the CBOE Volatility Index (VIX) surges, on average, by 50% or more within the next two months. The only exception in recent history was in 2007. “It doesn’t necessarily mean stocks will decline, but it does seem to be a good bet that at some point the VIX will jump,” Goepfert noted.
Despite Goepfert’s comments, the VIX is often called the “fear gauge” for the market because it tends to rise when stocks fall.
Significance For Investors
Goepfert’s four gauges are: (1) plunging numbers of bearish bets versus bullish bets in the options market, as measured by the 10-day put/call ratio; (2) the cost of buying downside protection with put options is falling relative to the cost of buying upside potential with call options, as measured by the S&P 500 put-call skew; (3) hedge funds have created a record high net short position in the VIX, a big bet that volatility will stay low; and (4) the gap between the prices of the four-month and two-month VIX contracts is the highest since January 2018, implying that some investors are looking to profit from higher volatility down the road.
Some investors say a surge in volatility could be followed by huge declines and losses. “It’s a very unusual time,” says Jim Carney, the CEO of Parplus Partners, a hedge fund that focuses on trading strategies linked to volatility. He is certain that an upswing in volatility is inevitable, though he does not know when. Right now, he sees a “bubble” in the options market, with a preponderance of bullish bets that are paying off as the market rises, but which can produce big losses should volatility spike, as happened in February 2018.
The VIX opened on Nov. 20 at a value of 13.42. Its 52-week high of 36.20 was reached during intraday trading on Dec. 26, 2018, the same day that the S&P 500 bottomed out from its massive December selloff. The movement of the VIX this year shows a trend of rising bottoms, but appears to have a met a resistance level in the upper 20s, according to a column in Barron’s. That technical analyst predicts that, should the VIX have a weekly close above 32, it is likely to rise to a range between 50 and 55.
Meanwhile, the Investopedia Anxiety Index (IAI) has been registering neutral levels of concern. It’s a proprietary measure of investor sentiment, based on the most-viewed Investopedia articles by readers around the world.
Author: Mark Kolakowski
Source: Investopedia: Why Investors Should Brace for a 50% Volatility Spike and Steep Losses