Monday, May 15, 2017

How I learned to stop worrying and love the low VIX

Investor angst has been rising over the low level of the VIX Index. A simple glance at Google Trends tells the story of rising anxiety.

The VIX Index fell to single digits last week, though it recovered to above 10 by the end of the week. Nevertheless, current levels represent multi-year lows.

James Picerno at Capital Speculator demonstrated in the chart below that changes in the VIX are inversely correlated with stock prices. The combination of a low VIX and the inverse correlation has a lot of people questioning if a VIX spike could spark a rapid or disorderly equity market sell-off.

The doomsters should calm down and stop reading Zero Hedge. There are several good reasons for the low level of the VIX Index:
  • Realized equity volatility is low
  • Other asset class volatility are low
  • Cross-asset correlations are low, which means that sectors and asset classes are more diversifying, and therefore depresses realized volatility
In that case, why shouldn't the VIX, which is anticipated volatility, be low? To be sure, a low vol regime does carry its own risks. When vol does spike, it will catch a lot of investors and traders by surprise and has the potential to cause a lot of damage to asset prices.

The full post can be found at our new site here.

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