Fears unleashed by the once-in-a-century pandemic are clinging onto volatility markets even as stocks boom to record highs and Wall Street speculators gorge on every risk.
For all the euphoria in markets, the Cboe Volatility Index has stayed elevated in an historic divergence between this gauge of investor fear and rallying equities. The VIX hasn’t closed below 20 since February last year. Its current level of 23 is some six points above the decade average.
As Dean Curnutt at Macro Risk Advisors puts it, the VIX is “on an island of its own.” And there are no easy explanations.
As the market rotation reduces correlations and increases risk appetite, Wall Street strategists have long expected a spirited drop in the gauge, which uses the options market to measure the 30-day implied volatility of the S&P 500.
So here are four theories on why things are not so simple in volatility land.
The Aftershocks
First and foremost: Past is prologue. Historically, volatility shocks like the Covid-spurred mayhem in March have taken time to run their course. After all, implied volatility largely reflects what’s recently happened in markets. In the wake of the global financial crisis, it took some 15 months for the measure to normalize.
Yet it’s been just 10 months since the stock wipeout that sent the VIX soaring to a record.
Given precedent, it could be several months before the fear gauge settles at a more subdued level especially in light of the extended collapse in the global investment and consumption cycle.
“The VIX dropped off more quickly than usual but now has entered a slower decline,” said Vance Harwood of Six Figure Investing, a consultancy specializing in volatility. “We are just seeing the normal after-effects of a market crash.”
Add delays to vaccine roll-outs, and there are good reasons why it’s a long journey back to a pre-pandemic normal of sorts.
Blame Tech
Perhaps something else is at work too. Hedge fund Man Group, for one, blames the increasingly large weighting of technology in the S&P 500 Index.
Tech shares are now approaching a 30% weighting in the U.S. stock benchmark, up from around 20% five years ago, according to Man. Over the past year, investors have piled into these names as part of the stay-at-home trade, leading to sharp sell-offs when sentiment reverses.
When a volatile sector comes to dominate the benchmark, “we get more instances of simultaneous increases in equity markets and volatility, notably during the tech bubble of the late 1990s,” strategists at the firm wrote in a note. “Indeed, we see a similar make-up of the S&P 500 today.”