The stock market continues to hit new highs while experiencing very little volatility and few notable sell-offs. The CBOE Volatility Index — aka the VIX, aka the “fear gauge — closed on Friday at 11.3, its lowest level since March 2013.
All of this has some experts freaked out that complacency has run rampant, making markets more vulnerable and sensitive to bad news.
While this might be true, history shows that a low VIX isn’t a great reason to dump stocks. Sure, the VIX may eventually move higher as market volatility returns. But there’s little indication that it will happen soon.
“Looking back at volatility data reveals that there are much higher probabilities for market gains when the VIX is sitting between 10 and 15 than when it is in the 20-25 range,” said Citi’s Tobias Levkovich during a luncheon earlier this month.
Since 1990, a VIX at current levels saw positive returns over 3-month periods 75% of the time, 6-month periods 86% of the time, and 12-month periods 88% of the time. The average 12-month return was 11.1%.
For those looking for short-term trades based on the VIX, the best opportunities seem to occur when it falls below 20 or jumps above 30.
To be clear, Levkovich’s market outlook doesn’t rely on the VIX alone.
“We continue to think that a 1H14 correction (in the 5%-10% range) is possible given weak EPS forward guidance trends and previous euphoric investor sentiment, not to mention the impact of the yield curve’s shape on future market volatility,” he said. “While credit conditions remain favourable in the US, disappointment in emerging economies and a lackluster though improving Europe could hold back the earnings story. Admittedly, better hiring intentions are encouraging. Plus stock buyback activity has stepped up and money has begun to flow into equity funds. With a 1,975 S&P 500 target by year-end 2014 driven by EPS gains as economic conditions improve next year, we remain generally constructive longer term while continuing to advise nearer-term tactical caution.”
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