Market Panic? Not According to the Volatility Index

Sell in May” is in full swing this month, with stocks down roughly 4% from their late-April peak. The Dow Jones Industrial Average has fallen for five straight weeks, its longest losing streak since 2011. Small-cap stocks have slumped even worse, down as much as 9% since May 6. All of that feels like panic. But one area that panic hasn’t surfaced is the CBOE Volatility Index (VIX).

Known as the “investor fear gauge,” the CBOE Volatility Index is a forward-looking, options-based measurement of investor anxiety. A spike in the VIX is typically either in line with or a precursor to a big selloff in the market. And for that reason, the absence of any major spike in the VIX during the recent round of selling stands out.

As of this writing, the VIX is trading in the mid 16s—less than half of what it was (36) on Christmas Eve, when the market bottomed, and down from where it was two weeks ago, when the index jumped from 16 to 20 during the market’s initial leg lower. That was the last true spike in the VIX. So does that mean that the worst of the selling is behind us, and traders are anticipating less volatility ahead?

For the answer to that, I’ll defer to Jacob Mintz, our options trading expert and Chief Analyst of our Cabot Options Trader advisory. Jacob would know what the CBOE (which stands for “Chicago Board of Options Exchange”) is telling us more than most because he worked as a market maker on the CBOE floor for more than a decade.

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Here’s a sampling of what Jacob told his subscribers about the volatility index yesterday morning:

“The Chicago Board of Options Exchange Volatility Index (VIX) closed (last) week at 15.85, or virtually unchanged. It’s interesting that the VIX barely flinched even as the market again came under pressure. I am becoming a bit intrigued by the lack of fear shown in the VIX even as the market has declined. Here are my two theories about why this may be the case:

“1. Traders are already hedged as the U.S./China trade war has been a known event for some time.

2. Traders aren’t worried about a big market decline as they assume a continued market fall or a slowing global economy will push a trade deal to be completed, or the Federal Reserve will be forced to cut interest rates, which would likely stabilize the market.”

In other words, investor fears are already baked in and/or Wall Street is anticipating a positive catalyst to counteract all the trade war fears. Either way, the lack of investor fear is encouraging.

Trade war aside, it’s possible that after four months of virtually uninterrupted gains to start 2019, the market was due for a correction, and everyone knew it—hence, the lack of panic. By that same token, perhaps investors aren’t expecting that correction to last much longer, regardless of what comes out of Donald Trump or Xi Jinping’s next regarding trade.

If the VIX suddenly spikes in the coming days, that could be a sign that the selling isn’t over. But if it stays at current levels, then the chances of a forthcoming market rally seem strong.

Either way, keep an eye on the volatility index. It could be a window into whether it’s safe to start adding to your portfolio again.

Chris Preston

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Investment analyst and Chief Analyst of Cabot Wealth Daily, Chris Preston brings you all the latest from the investing world. Sign up to get updates and breaking news delivered FREE to your inbox. Get unlimited access to our library of complimentary investing reports.

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