As the votes are cast in the US election the so called fear index or VIX surges. If the markets hate uncertainty then there is plenty of it to go around.
Markets embrace fear as uncertainty becomes the new normal
The VIX index, or fear index, is up. Usually this implies sharp falls in stocks ahead.
The VIX index, or CBOE Volatility Index, to give the index its full name, but often referred to as the fear index, was created by the Chicago Board Options Exchange (CBOE). It is calculated by applying a formula broadly based on the volume of put and call options — “the square root of the risk-neutral expectation of the S&P 500 variance over the next 30 calendar days and is quoted as an annualized standard deviation.”
As I write these words, I can hear the voice of the political commentator Andrew Neal. His conclusion: “Either Mr Trump or Mr Biden could win this election.” Or to put it another way, we have no idea. It seems highly likely that postal ballot votes, which may not be counted for several days, will determine the result. And if postal vote favours Mr Biden, then President Trump will contend its legality. I wake up this morning to a US election that really is on a knife edge. Uncertainty is the name of the game. The US is a divided country — it seems you either love or hate Mr Trump. I often read that there is a real risk of a civil war in the US. Yesterday, I heard a report from the BBC’s Jon Sopel talking about businesses shutting down in the US on election night because of fears over social unrest. He painted such a gruesome image, I had to listen to the report again, just to check he was talking about the US.
And the markets reflect this.
The VIX index stands at 35.5. This seems to tell us that the S&P 500 is likely to rise or fall by 35 per cent. The index has only been higher on four previous occasions. The record was set in 2008, when the index peaked at over 70. Between September 2008 and April 2009, the VIX was higher than today. It also spiked at a level which was over 35 in May 2010 and again in April 2011 — this was during the period of talk of a double dip recession and the euro crisis.
Then on March 27 this year, the VIX hit 65, as the implications of Covid sunk in.
In the past, when the VIX peaked, the broader stock market fell. But whether the VIX really is a reliable indicator of future movements or merely a reflection of what the stock market has already done is controversial.
Daniel Goldstein and Nassim Taleb (author of the Black Swan) wrote an often cited paper entitled: “We Don't Quite Know What We are Talking About When We Talk About Volatility.”
But I think that when the index sees a big spike, like we are seeing at present, then we can’t ignore it.
Uncertainty is back, the markets hate uncertainty and the VIX or Fear Index is giving us hard numbers to ponder.
However, while a surge in the VIX often seems to be a good prediction of a fall in the S&P500, this is not always the case. The stock market did stutter in 2010 and 2011, a few months after a spike in the VIX, but it soon recovered, and when we look back now, such falls look like blips.
If the VIX has meaning, the S&P 500 should be in for sharp moves — but just as that means it could fall, it could also mean it will rise.
But we are in uncertain times — no one knows where Covid-19 is going to take us. The markets have got quite used to this uncertainty. They have become used to fear.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.