Tracking Market Volatility

CNBC takes a look at the VIX, also known as the volatility index, a gauge of fear and risk in the stock market. They point out that since the stock market bottomed on March 6th and rallied through today, the VIX has now dropped over 30% while the S&P 500 has rallied about 30%.

It was interesting that the article noted that "some analysts view the drop as indicative of a more positive mood in the market..." NOT EXACTLY.

Between November 21st and January 6th, the S&P 500 rallied about 27% in a classic bear market rally. During that same period the VIX went from a high of 80.74 down to a low of 37.34, a stunning drop of over 50%! But was that a sign that the worst was over? NOPE. The market fell almost 30% during the next two months and the VIX bounced almost 40% of its low.

The VIX is not necessarily a future indicator, it merely acts in an inverse fashion to the S&P which is the index it is based on. However, the action in the VIX during this market rally, which many are quick to write off as just another bear market rally, has been interesting but for a different reason.

The real question is why the VIX has not fallen more given the extreme nature of the rally. We would argue that the VIX is signaling that there is still some fear and a reluctance to believe in the rally. If that is the correct view, that is a great sign for the markets going forward.

If the crowd truly believes that this is a suckers rally, the VIX should stay slightly elevated as traders continue to hedge and protect their investments. That shows that we are not at a point of excess optimism (although one sentiment indicator argues differently). Only in the last day or two has the VIX started to breakdown a little bit which again is a positive for the markets.

In the short term the S&P is approaching resistance and although volume was solid today, this rally is starting to look a little overbought for the moment. Once we get options expiration out of the way tomorrow it will be interesting to see how the market reacts next week. When the pullback comes it will be interesting to see whether the VIX is quick to jump back up for fear that this rally will end like the rest. It will be a good tell for the real strength behind this unstoppable market momentum.