Why 2020's Crash Isn't Lining Up With the 2008 Financial Crisis

An aggressively plummeting VIX could indicate that the market bottom is behind us

Senior Vice President of Research
Apr 27, 2020 at 8:42 AM
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With the SPX 23% above its March closing low but still 16% below its February all-time closing high, the bears are pinning their hopes that an area between 2,900 and the 3,000-millennium level prove to be harder to overcome than the levels I mentioned last week as potentially dangerous... a wide area between 2,630 and 2,800 represents potential support.”

            - Monday Morning Outlook, April 20, 2020

While not its first pause since the March 20 low, the S&P 500 Index (SPX – 2,836.74) pulled back last week, without a serious go at the first of multiple potential resistance layers immediately overhead. I also discussed this in last week's Monday Morning Outlook, as mentioned above.

In fact, since first touching the 2,800-2,811 area on April 9, the SPX has gone sideways, rewarding neither short-term bulls nor bears during the two-week stretch. The round 2,800 century mark is the level from which the December 2018 correction began, and 2,811 represents a 50% retracement of this year’s closing high and low. 

April 26 MMO Chart 1

the VIX has moved down to a level that is roughly half last month’s high, which is also three times the 2019 close. Might those that view a "50% off portfolio protection sale" drive index and exchange-traded fund (ETF) put buyers who desire portfolio protection? …[I]n December 2008, the VIX pulled back and leveled off in the 40 area for months, as the 40 area marked one-half its October and November 2008 closing highs. As it languished around 40, the S&P 500 Index (SPX -- 2,789.82) traded sideways before its final descent into its March low... If you are a short-term trader, keep in mind that resistance levels reside just overhead, and if the VIX behaves like late 2008-2009, it could be indicative of choppy waters ahead and one more scary decline.”

            Monday Morning Outlook, April 13, 2020

April 26 MMO chart 2

Even though we have witnessed choppiness during the past two weeks, with a wide area of support and resistance zones immediately above and below, the Cboe Volatility Index’s (VIX - 35.93) Friday close was encouraging for bulls. In addition to closing below the previous week’s low, it closed more than 10% below its half high. Per the excerpt above, while the VIX experienced a few days below its 2008 half high, it never closed more than 10% below it, and such moves below were very short in nature, as months of sideways action developed before the SPX final descent into the March 2009 low. Plus, Friday’s stock rally and volatility plunge was on the heels of another near $500 billion stimulus package to support small businesses.

As of now, a couple of things are looking different with respect to the 2007-2009 bear market and this year’s plunge in both the economy and the stock market:

  1. The Fed has acted much more aggressively in cutting rates, and massive stimulus packages have come much sooner, unlike how the slower-moving financial crisis unfolded. This is likely because the pandemic-related crash in the economy was deeper and unfolded much more quickly.
  2. As a result of huge Fed rate cuts and enormous stimuli as soon as the economy imploded, volatility expectations, as measured by the VIX, have plummeted more aggressively, perhaps indicating that the bottom is in, instead of a prolonged bottoming process

Would it be a major surprise if volatility expectations continue to decline? Not really.  After all, note how large speculators on CBOE Market Volatility Index futures, who have a near perfect batting average on being wrong ahead of major turns in volatility, have an unusually small net short position on VIX futures. This same group had a huge short position on VIX futures ahead the last volatility spike.

April 26 MMO Chart 3

According to an Evercore ISI survey of institutional equity managers and hedge funds, exposure to more economically sensitive industries versus more classically safer ones has fallen to the lowest ever in data going back to 2004.”

                - Bloomberg News, April 23, 2020

In the meantime, many sentiment indicators that we track have signaled either multi-year highs in pessimism or levels of fear on par with that of the 2009 bottom, a necessary condition for a bottom to be in place. The excerpt above is yet another example of the extreme caution in the investment community.    

I have highlighted many other sentiment indicators during the several weeks. They include: the actions of fund managers, the equity exposure of active investment managers, the behavior of the options crowd with respect to less demand for hedging, due to less to protect, and options buying from a speculative perspective. Additionally, I will note that the 10-week moving average of the percentage of bears just hit its highest level since July 2009 in the weekly American Association of Individual Investors (AAII) survey.

While sentiment measures suggest bullish action in the months ahead, the technical outlook suggests many hurdles ahead in the short term. This might contribute to a slow grind higher, with a lot of sector rotation, as big inflows into defensive names by some fund managers have supported the market, in addition to massive short covering in the second half of March that accounted for a strong finish to last month.

April 26 MMO Chart 4

Todd Salamone is Schaeffer's Senior V.P. of Research

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