A dramatic rise in the United States Volatility Index (aka the VIX), often dubbed Wall Street’s ‘fear gauge’, suggests that investors are spooked by the most turbulent stretch for equity markets since U.S. President Donald Trump’s fated Liberation Day tariffs were announced early April.
As a popular measure of the share markets' implied volatility expectation based on S&P 500 index options, the Cboe Volatility Index, or VIX rose as high as 28.99 on Friday – its highest level in six months.
As a result, investors piled into options contracts against the S&P 500 - as a hedge against market declines - that would pay out if the VIX surges to 47.5 and 50.
Admittedly, the VIX - Wall Street's most watched gauge of investor anxiety - is now trading at 20.78 but analysts are concerned that recent spikes portend of upcoming market downturns.
According to IBD research, when the VIX rises more than 20% above its 10-day moving average, it often signals a positive reversal in the market.
The signal has occurred several times this year, including 7 April, 23 May, 13 June, 1 August, and 2 September. Each time, the S&P 500 made a low or was near a low.
How the Vix and S&P 500 are linked
For starters, what the VIX actually does is track expectations for stock swings over the next 30 days, based on what investors will pay for options tied to the S&P 500 index.
When fear is rising, traders are typically more likely to pay up for options to protect their portfolios, meaning the VIX tends to spike when the market falls away.
Understanding the nexus between the VIX and S&P 500 correlation is crucial for any investor in U.S. stocks trying to navigate the market’s current turbulent waters.
The VIX often moves inversely with the S&P 500, making it a vital indicator for tracking market bearishness.
When the VIX rises sharply, it often signifies that the S&P 500 is experiencing a sell-off, and this pattern is a classic display of acute investor concern in action.
For example, as the VIX surged to 28.99 during recent trading, the S&P 500 faced downward pressure.
Manage risks
By observing the VIX and its relationship with key indices like the S&P 500, you can gain valuable insights into market sentiment, potential volatility and get better at managing risk and preparing for market shifts.
The recent – albeit short-lived – major surge in the VIX index signalled to many traders that it’s time to reassess their portfolios.
Given that the laundry list of worries confronting the market – including geopolitical tensions, Trump’s tariff threat, the federal government shutdown and restrictions China has placed on exports of its rare earths - is actually increasing, analysts are quick to expect higher volatility.
Compounding those worries are growing concerns over credit quality across the private equity sector and a steep fall in shares of regional banks – due to poor lending standards and bad credit exposures - which only raises concerns that the U.S. economy is weaker.
Adding an additional layer of angst, there are growing doubts on the big ballsy [investment] bets on AI that helped carry stocks from their April lows to new all-time highs.
Unsurprisingly, analyst forecasts are quick to flag the possible quick reversals or prolonged periods of instability based on historical VIX trends.
Given that the year high for the VIX was 60.13, traders remain vigilant to possible upswings that could impact equities globally.
"The market is becoming more volatile, but it's also coming off of a very non-volatile period where we didn't have a lot of risk catalysts bubbling to the top," said Michael Reynolds, vice president of investment strategy at Glenmede.
"Once you have valuations hit sort of full levels, as we're seeing now, almost across the board, you have to be on the lookout for incremental risk catalysts."
How to understand what the VIX index is telling you:
- 0-15, this usually indicates optimism in the market and very low volatility.
- 15-25, there is typically a moderate amount of volatility, but nothing extreme. A VIX in this range are indicative of a normal market environment.
- 25-30 indicates some market turbulence; volatility is increasing and investor confidence may be waning.
- 30 and over typically indicates some anticipation of extreme swings in the market.
S&P 500 versus the VIX index
All eyes will be on third-quarter earnings after major banks started the reporting season on a strong note.
Apart from streaming giant Netflix and electric vehicle maker Tesla, other companies due to report in the coming week include consumer companies Procter & Gamble and Coca-Cola, aerospace & defence giant RTX, and tech stalwart IBM.
The corporate results and executive comments will offer insight into the economy, as the U.S. government shutdown has stopped economic data releases since October 1, including monthly employment data.
Corporate "reports and what companies say is really our best chance at assessing what the broader economic health is," said Kevin Gordon, senior investment strategist at Charles Schwab.
The U.S. government is expected to release the consumer price index for September on Friday, nine days late, noting that the CPI data allows the Social Security Administration to meet deadlines for timely payment of benefits.
Meanwhile, the CPI report, which is a closely watched inflation gauge, will be released days before the Federal Reserve's next monetary policy meeting on October 28-29.
The U.S. central bank is widely expected to cut interest rates by a quarter percentage point again, after weakening jobs data prompted the Fed to lower rates last month for the first time this year.
"We'd really have to see something out of left field in terms of notable inflation pressures to knock the Fed off of a rate cut path at the October meeting," Glenmede's Reynolds noted.
