Stay Cautious: "Fear Gauge" at a Crossroads

The VIX is at 50% above its 2022 close

Senior Vice President of Research
Mar 20, 2023 at 9:24 AM
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Last week was a crazy one for market participants, on the heels of uncertainty related to arising problems in a few regional U.S. banks, plus one major bank overseas, Credit Suisse (CS).

Government and private sector actions that were taken to stabilize the system, at least for now, made for a particularly volatile week in the Treasury market. For example, in only a one-week period, fed funds futures traders assigned zero probability that the fed funds rate would be lower in June than it is at present. But by Wednesday, the implied odds that the fed fund rates would be lower in June climbed to nearly 80%. By Friday’s close, the probability that the fed funds rate would be lower that it is now was back to less than 10%.

Despite the rampant volatility in Treasury’s, equities managed to close higher on the week. However, all is not necessarily well in the equity world from a technical perspective.

If you are looking for the next ‘line in the sand’ of potential support, it is between 3,835 and 3,850, with 3,835 representing the level that is a round 20% below the all-time closing high and 3,840 the site of the 2022 close. The 3,850 level is

important for a couple of reasons: 1) it is the level at which the SPX closed when President Joe Biden took office and 2) it is the current site of the extended trendline connecting major lower highs in 2022. A break of this area would likely mean a retest of the November closing low in the 3,780 area or the October closing low at 3,577the decline below the 3,940-3,970 area increases risk in the market significantly. Moreover, an immediate risk that you don’t see on the chart is standard expiration of March options on Friday.”

            -Monday Morning Outlook, March 13, 2023 

It was a roller-coaster type week for stocks as well, with the S&P 500 Index (SPX-3,196.64) more than 50 points below the previous week’s close on Monday morning, and 100 points above the Friday, March 10 close by Thursday’s close, before a sell-off occurred to end the week.

For bulls, it was a good news/bad news week. On one hand, the support area highlighted in last week’s outlook held true for most of the week. Moreover, the elevated delta-hedge selling risk that I discussed did not come to fruition, as governments and the private sector acted to stabilize a still uncertain situation in regards to the banking sector.

But the S&P 500 Index’s rally off the week’s low stalled at the 3,940-3,970 area, which I have highlighted in previous weeks as a critical area of support, per the bold in the excerpt above. With the SPX coming into the week below this key area for the second week in a row, I still maintain that there is significant risk in the market. 

SPX Daily with 200-day MA

It is encouraging that the SPX 3,835-3,850 area was supportive, but it remains to be seen if this area is just a pause before more selling occurs on the way to the October lows in the 3,500 range, or represents a major pivot where buyers emerge for a sustained period. For now, my advice would be to remain cautious, with the SPX not only below the key 3,940-3,970 area, but also below a trendline that has surfaced in recent weeks that connects highs since the February peak. The trendline comes into the week at 4,035 and ends the week at 4,010.

If the SPX moves below 3,835-3,850, the round 3,800-century mark becomes the next potential pause or pivot point. This level not only marked multiple daily lows during December but is the site of a trendline breakout in October 2022. For what it is worth, at this week’s end, the 3,824 level is the site of the extended trendline that connected all major lower highs in 2022.

“…the VIX advanced above a trendline connecting lower highs since the December peak. This could be hinting at a couple of things: 1) a correction on the horizon and/or 2) the path for bulls will not be as smooth in February as we saw in January. This is in context of VIX futures option buyers purchasing calls relative to puts at a rate of five to one. Historically, these option buyers have been smart money…”

         -Monday Morning Outlook, February 13, 2023 

If the VIX closes above last year’s close, I think it would be worth growing more cautious about a continued rise in volatility that is concurrent with lower stock prices…Using history as a guide, I think risk grows of the VIX getting up to at least the 27 area, or 50% above this year’s closing low, if it moves above its 2022 close. A move into the 32 area would also be a possibility, which is 50% above last year’s close. As such, it would be worthwhile to hedge this possibility while the VIX is in the low 20’s.

            -Monday Morning Outlook, February 21, 2023 

MMO Tweet 3152023  

I would also remain cautious as long as the Cboe Market Volatility Index (VIX--26.12) remains above its 2022 close at 21.67. During the past month, I have made various comments with respect to various VIX levels to watch as barometers for increased risk in the market.

Per the excerpts above from past commentaries, the VIX was hinting at potential trouble ahead for bulls in mid-February and again in late February. With the SPX down nearly 8% from its early-February closing high to last Monday’s close, and most of the losses occurring since mid-February, I think it is fair to say that the VIX served as an early warning signal. During this period, the Fed has cautioned traders that there is a lot more work to be done in fighting inflation than investors were assuming, and more recently, the bank failures.

With a Federal Open Market Committee (FOMC) meeting this week, and expectations for a 25-basis point rate hike, the VIX has not yet closed above 26.80, which is 50% above the 2022 close. This could be indicating that buyers of portfolio insurance are fully hedged, or don’t view the current environment as treacherous enough to buy portfolio insurance at an implied volatility that is 50% above what they could have purchased it for at the end of 2022.

Tuesday marked the biggest day of inflows into money market funds, according to Goldman Sachs and EPFR, a data provider…Inflows by retail investors into money market funds have been ‘large and accelerating’ over the past week, Goldman Sachs wrote in a note on Thursday.”

            -Financial Times, March 16, 2023

The bottom line is the VIX is giving us mixed signals as we move into this week. Yes, a peak could be in at 50% above last year’s close, and that could be coincident with higher equity prices. At the same time, with the VIX still above last year’s close, caution is still warranted.

If you are tempted to go long equities here, tempted by the potential that investors may be moving out of stocks and into money market funds at the wrong time, I would advise doing so with a short leash on your stop. The market’s behavior of late is not exactly suggesting such actions are unjustified.

VIX Six-Month Daily

Also, beware that March VIX futures options expire Wednesday morning, with the last day to trade such options on Tuesday. As it stands now, March VIX futures could settle in the 23-24 zone, which is where the maximum number of put and call options would expire worthless. As such, the next big move in the VIX, whether higher or lower, may not come until after VIX March futures option expiration Wednesday morning and the Fed’s comments Wednesday afternoon.

March VIX Futures OI Config

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

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