The Chicago Board Options Exchange’s VIX volatility index is often referred to as “Wall Street’s fear gauge,” and it is currently showing that investors aren’t scared.
The VIX currently stands close to its lowest rate since January 2020 — before all the turmoil of the COVID-19 pandemic — and at these levels investors have been happy to push along the equity rally for seven or eight weeks so far.
Over the year the S&P 500 index has added 24%, and the exchange-traded fund that closely follows it — the SPDR S&P 500 (NYSE:SPY) — putting on the same.
But what can it tell us about the future? Any investment tool that claims to accurately predict the future performance of an asset or security is a scam. But, while the VIX index isn’t a precision instrument, it can be a barometer of market sentiment.
Take a look at the chart below, which measures the Barclay’s iPath Series S&P 500 VIX Mid-Term Futures (NYSE:VXZ), an exchange traded product that tracks the VIX index, against both the S&P 500 and the NASDAQ index.
It has a considerably accurate inverse correlation with the equity market. Thus, as the VIX falls, stocks tend to rally, and vice versa. Investors are expecting a Santa rally and extended gains into 2024, thus, the VIX reflects this sentiment.
Also Read: ‘Magnificent 7’ Widens Gap With Rest Of S&P 500, But That May Change In 2024
How Does The Vix Work?
It can’t predict market shocks — let’s get that straight. A couple of weeks before the collapse of Lehman Brothers at the height of the 2008 financial crisis, the VIX was trading around the 20 level — consistent with low levels of volatility.
The index’s value is derived from the prices of S&P index options with near-term expiration dates, which allows a 30-day forward projection of volatility.
But by its very nature volatility is volatile and can happen anytime. Thus, the VIX can’t predict unseeable events such as a bank collapse, it can only respond to them.
Does It Foresee A 2024 Rally?
And so, the VIX at current levels is responding to the high levels of risk appetite present in the financial markets following a strong couple of months for equities. But it can’t predict that this is going to continue in 2024.
What it can tell us is that investors are happy to push equities higher in the absence of…
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