US volatility indices show persistent investor ‘fear’ after rally

Investors are betting on big swings in US stock prices, even as benchmark equity indices push steadily higher and darlings like Tesla and Amazon surge to new records.

The Cboe’s Vix index of equity market volatility, often referred to as Wall Street’s fear gauge, remains 41 per cent above its historic average at nearly 28. Another longer-term measure of US stock volatility is 50 per cent above its long-term average, according to the Cboe.

The indices are well below the highs they struck during the sharp market falls at the depths of the coronavirus crisis earlier this year. But the persistently lofty levels indicate investors are still bracing for potential shake-ups in the US benchmark S&P 500 equity index, reflecting unease over the scale of the market recovery since March.

Line chart of Vix volatility index showing US stock market volatility remains above its historic average

“Today’s level for the Vix is perfectly indicative of how uncertain this situation is,” said Randy Frederick, vice-president of trading and derivatives at Charles Schwab. “One of the challenges of this environment is that we are all basically trying to fit historical models and patterns [on to] today’s scenario,” he added. “The reality is the scenario today is unique.”

Aggressive action from the Federal Reserve and the US federal government has helped to ward off a more pronounced financial and economic crisis from the spread of Covid-19. Their interventions have helped fuel a recovery rally in stocks. The tech-heavy Nasdaq Composite hit a record high on Tuesday, while the S&P 500 came within 6.2 per cent of its all-time high.

Line chart of Year-to-date performance (%) showing Technology stocks have led the Nasdaq and S&P 500 higher

Investors, both professional and retail, have a wide range of views over what happens next. The number of call options — which enable users to capitalise on rallies — continues to push higher, indicating an undercurrent of optimism.

Still, Kristina Hooper, chief global market strategist at Invesco, said the fears that have kept the Vix elevated compared with historical norms are also reflected in other markets, including US government bonds. The yield on the 10-year Treasury bond remains close to a record low at 0.67 per cent, reflecting persistent investor demand for haven assets. Gold, which is often bought during times of crisis, has rallied 18 per cent this year and on Tuesday was at an eight-year high.

Line chart of Total equity and index option volumes in the US (m) showing Options trading has boomed this year

As the economic damage from the outbreak becomes clear, “there is a fear of fundamentals ruining the party,” said Ms Hooper. She also warned that additional support was needed from Washington.

“The need for ongoing fiscal stimulus is critical,” she said, adding that without it, especially if infections continue to rise, “that could be something of a perfect storm that could manifest in late summer and early fall”.

Many states are struggling to contain the coronavirus outbreak. Cities around the country have slowed their reopening plans, while states including Texas that had pushed to ease lockdown measures are tightening restrictions again after a sharp rise in cases.

November’s presidential election presents another potential source of volatility. Mr Frederick said he would be “shocked” to see the Vix fall below 20 before
the nation goes to the polls.

Source Article