Could a Spiking VIX Mean Stocks and Index ETFs Move Higher?

With stocks and index ETFs losing more than 3% over the last couple of days, volatility, as measured by the VIX, has been spiking.

After a period of enduring complacency, the CBOE Volatility Index, a measure of fear in the markets based on option prices on the S&P 500, surged as high as 23.73 this week, to levels not seen since March. A rising VIX is often accompanied by falling markets, and a score above 20 can indicate a protracted period of declines.

Yet, with the VIX moving toward its highest in two months, some analysts are now suggesting that the index is actually sending a bullish signal for a relentless stock rally that has continued to run despite lofty valuations.

While the VIX has dropped steadily as stocks and index ETFs have continued their relentless climb higher since the lows of February 2020, for Michael Purves, CEO of Tallbacken Capital, the jump in the VIX is a sign that investors are piling into the bull market with their defensive hedges already in place, something Purves believes offers protection from blow-off tops.

“This high premium to realized volatility actually helps reinforce the bullish trend,” Purves said. “If the spread to realized was very low we would be much more concerned about complacency.”

Although the VIX jumped 10% on Tuesday, after climbing over 5% Monday, analysts are still noting that the S&P 500 and other key indexes finished eight out of the last ten weeks with gains. The notorious benchmark has plodded higher in the face of climbing bond yields, historic valuations, and a decline in new hires.

Interestingly, when JPMorgan Chase & Co. strategists noted a similar “bubble” in the VIX in March, the S&P 500 proceeded to add almost 4%.

Both Purves and Sundial Capital Research Inc. founder Jason Goepfert also noted that there are a significant number of S&P 500 stocks still trading above their 200-day moving averages.

On average last month, 96% of stocks traded above their 200-day moving averages, Goepfert wrote in a note Friday, making it one of the best periods for breadth in data going back to 1928, something that has often ushered in additional highs.

“Overall, stocks held up well after other thrusts, especially over the next two to three months,” Goepfert said. “The biggest issue now is that the few other times these kinds of thrusts triggered when stocks were relatively close to their highs, only once did we see large, sustained gains right away (in 1982).”

Famous investor and hedge fund manager Stanley Druckenmiller offered investors words of caution to investors this week, stating that while he was not completely out of stocks, they were in a “raging mania” and that the Fed and U.S. government might be endangering the U.S. dollar’s reserve status by providing too much stimulus into an already surging economy.

“I can’t find any period in history where monetary and fiscal policy were this out of step with the economic circumstances, not one,” Druckenmiller said. “If they want to do all this and risk our reserve currency status, risk an asset bubble blowing up, so be it. But I think we ought to at least have a conversation about it.”

To that end, periods where the VIX was consistently above 20 have included: the US recession of 1991, the emerging market financial crises in late 1990s, the US recession of 2001, the US recession of 2008, the European financial crisis of 2012, and most recently, the US recession of 2020.

For traders who see stocks continuing to head higher, the ProShares Short VIX ETF (SVXY) climbs as the VIX falls. According to the fund’s profile: “The investment seeks daily investment results, before fees and expenses, that correspond to one-half the inverse (-0.5x) of the performance of the S&P 500 VIX Short-Term Futures Index for a single day. The index seeks to offer exposure to market volatility through publicly traded futures markets and is designed to measure the implied volatility of the S&P 500 over 30 days in the future.”

Meanwhile, investors looking to use ETFs to trade the VIX as it moves higher over the short- or long-terms can look to the iPath Series B S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX) and the ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY), along with the CBOE Volatility Index. Potential investors should keep in mind that VIX-related exchange traded products track VIX futures and not the spot price. Notably, the VXX and VIXY are both up roughly 6% Monday, amid a 5.74% move higher in the underlying index.

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