Where Will Stocks Go After The VIX Implosion?

The SPX has tended to underperform after sharp weekly drops in the VIX

Jul 5, 2016 at 10:53 AM
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Last week's huge gains in the stock market corresponded with an absolute implosion in the CBOE Volatility Index (VIX). In fact, the VIX -- otherwise known as the market's "fear gauge" -- suffered its biggest weekly drop ever, surrendering 42.7%. Below, we'll take a closer look at how the VIX has performed after other sharp slides, and also examine what happens to stocks, using the S&P 500 Index (SPX) as a benchmark.

Schaeffer's Senior Quantitative Analyst Rocky White cooked up the chart below, which shows all weekly VIX drops of at least 20%, dating back to 2010. As you can see, last week's 42.7% plunge was by far the sharpest, with only January 2013's 39.1% drop in the same ballpark. Extending the search back to 1990, only one other time has the VIX surrendered more than 30% in a week (August 2007's 31% drop).

vix drops by year july 5

Below, White summarized the chart above, to give us an idea of where the VIX could go from here. As you can see, the VIX tends to outperform versus its anytime returns over the short term, while volatility tends to die down, per the standard deviation row. However, by three months, the post-drop VIX has historically underperformed, while volatility has spiked considerably.

vix drops july 5

What about stocks? Well, the charts below indicate the SPX has tended to underperform following the last 17 VIX drops of 20% or more. The average post-signal returns out to one month are negative, versus positive anytime readings. By three months, the SPX is back in positive territory, but its average return and percent positive significantly underperform the corresponding anytime readings (0.6% vs. 2.7%, and 58.8% vs. 72.7%). Long story short, sharp VIX drops over the past few years have historically been somewhat bearish signals for stocks.

spx after vix drops july 5

spx after vix drops by year july 5

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