Don’t Fear The Low VIX

With CBOE VIX index falling to the rare 9 level on Monday, there is significant consternation over the abnormally low level of the volatility. However, Bank of America Merrill Lynch, in a report out the same day as the VIX hitting historic lows, recognizes investor concerns with the low VIX but says not to worry. “Volatility can stay low and the secular bull market should continue.” In fact, markets could continue to break-out, with a particular bullish eye on Europe.

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As Fed official raises volatility concerns, BofA analyst Suttmeier says don’t worry about low VIX, be happy

The reduction of volatility is a significant concern, one echoed by Federal Reserve Governor Kevin Warsh at the Sohn Conference in New York. “I would not take comfort, I would take fear,” he was quoted as saying about the low VIX.

Market observers who follow the VIX note the oddities and often point to history as a reason for concern.

Suppressed volatility was an issue leading up to the 2007 collapse of Bear Sterns and the 2008 bankruptcy of Lehman Brothers, leading to the Global Financial Crisis. From October 2004 to June 2007 the VIX traded with a top range of 16.27 and a low end of the range at 10.42.

This statistically unusual narrowing of the volatility range pre-dated the catalysts of the Global Financial Crisis, an event that witnessed certain major stock indexes losing one-third to half their value – and the VIX index spiking to 59.89 October 1, 2008. This led to a period from 2008 to March 1, 2008, where volatility traded in volatile fashion, witnessing the VIX rise above 25 on several occasions. Volatility after this period traded mostly in a consistent range, with the exception of the August 2015 market crash. Today’s unusual market volatility, with the VIX touching 9.72, the volatility suppression continues.

Bank of America Merrill Lynch Technical Research Analyst Stephen Suttmeier doesn’t see an issue, however:

Many investors are concerned about when low volatility or complacency will lead to a deeper market drawdown. Using a 65-day moving average (MA) of the absolute value of S&P 500 price returns going back to 1928 suggests that the muted volatility since the April 2013 secular bull market breakout is the lowest since the 1950-1966 secular bull trend. This suggests volatility can stay low and the secular bull market should continue.

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Don’t worry, be happy: Watch for stock market breakout in Europe

From Suttmeier’s point of view, understanding the VIX cannot be done in isolation. It takes looking at a variety of markets to put the VIX’s historic move in perspective.

With US interest rates set to rise at the hands of the Federal Reserve, Suttmeier points out that it is during a period of falling interest rates, not rising rates, when volatility increases.

“The current secular bull market has low volatility and a low but perhaps rising US 10-year yield. This supports our view that the current secular bull market is similar to the 1950s secular bull trend,” he notes, looking around at a world where he sees bullish signs.

Key among the bullish viewpoint is Europe, a geographic region from which the recent French elections are pointed to as causation for the low volatility.

Suttmeier thinks the STOXX Europe 600 is the next stock index that is likely to breakout. He is watching resistance in the 400 to 415 range, highs put in during 2000, 2007 and 2015 – a triple top where all dates preceded a market crash. However, the BofA technical analyst doesn’t see this as an issue.

He says the triple top “suggests a lack of enthusiasm” and may be a positive sign. “A decisive move above 400-415 would confirm a 17-year base and breakout into a secular bull market with plenty of upside potential.”

The big question remains unanswered: if stocks continue to breakout to new highs, will market volatility, measured by the US-based VIX, move to establish new historic lows? This remains to be seen.