In an environment of extended low implied volatility as reflected by the CBOE Volatility Index, the equities market and stock exchange traded funds continue advancing as investors take advantage of pullbacks and buy the dip.
Currently, the drop in implied volatility corresponds with rising market conditions. The VIX is hovering back around 12.2 Wednesday, compared to historical average of 20. According to the CBOE, the VIX has averaged around 10.4 so far this year.
Year-to-date, the iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX), a VIX-related exchange traded note, and the ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY) have both declined over 35%. [Use VIX ETFs to Hedge Against Market Swings]
Meanwhile, the SPDR S&P 500 ETF (NYSEArca: SPY) and the S&P 500 index have gained over 8% so far this year, despite uncertainty surrounding the escalating tensions in eastern Ukraine, violence Iraq and Israel’s push into the Gaza Strip.
“Complacency runs very deep in these markets,” Nicholas Colas, chief market strategist at ConvergEx, said in a research note. “It will clearly take a lot to shift markets out of their current low volatility melt up; the ‘Buy the dip’ mentality is deeply ingrained in current investor behavior.”
Nicolas points out that the while the VIX has spiked over the past few years, none of the sudden increases have fueled a sustained rise in volatility as the downtrend kept resuming and stocks continued to rise.
“In short, investors and U.S. equities have what a New York couples therapist might call a ‘Constructive relationship based on trust, forgiveness, and shared values,'” Colas added.
Additionally, the strategist points out that the so-called VIX of major industry sectors from the S&P 500 are also down over the past month. For instance, financials show a 10.4% lower VIX now versus last month, tech stock implied volatility is 5.5% lower over the same period. The Financial Select Sector SPDR (NYSEArca: XLF) was down 0.2% over the past month while Technology Select Sector SPDR (NYSEArca: XLK) gained 1.2%.
However, fear is rising in the emerging markets, which showed a 10.5% increase in their VIX, but the volatility may be due to a mix of concerns over Chinese asset prices, Colas said. Meanwhile, fixed-income assets, specifically corporate bonds, are also experiencing a rise in volatility driven by concerns over large fund outflows.
For more information on market volatility, visit our volatility category.