By Saqib Iqbal Ahmed
NEW YORK (Reuters) – The panic appears to have subsided after the outbreak of volatility in U.S. stocks last week, but if history is any guide, markets could remain jittery for months to come.
Wall Street’s most closely watched gauge of investor anxiety, the Cboe Volatility Index, has fallen precipitously after closing at a four-year high last week, and stocks screamed back after the worst drop of the year. The S&P 500 is up 3% from last week’s lows, while the VIX is hovering around 20, well below its August 5 close of 38.57.
Investors pointed to the rapid dissipation of market turmoil as further evidence that last week’s crisis was fueled by the unwinding of huge leveraged positions, including yen-funded carry trades, rather than longer-term concerns such as global growth.
Still, turbulent episodes in which the VIX pushed higher have left show markets frothy for months after a boom, arguing against the kind of risk-taking that sent asset prices soaring in the first part of the year. A Reuters analysis found that the VIX took an average of 170 sessions to return to its long-term median of 17.6 once it closed above 35, a level linked to high investor fear.
“Once (the VIX) gets into a certain range, people will start to become a little more passive again,” said JJ Kinahan, CEO of IG North America and president of online broker Tastetrade. “But for six to nine months it usually wakes people up.”
This month’s turmoil in US stock markets follows a long, quiet period in which the S&P 500 rose as much as 19% this year to a record high in early July. Cracks emerged when disappointing earnings from some richly valued tech companies triggered a broad sell-off last month and pulled the VIX from its low-teens range.
More serious ruptures followed in late July and early August. The Bank of Japan unexpectedly raised rates by 25 basis points, putting pressure on players in a carry trade fueled by traders borrowing cheaply in the Japanese yen to buy higher-yielding assets from U.S. tech stocks to bitcoin.
Meanwhile, investors are assessing the likelihood of a US slowdown following a wave of alarming economic data. The S&P 500 fell as much as 8.5% from July’s records, narrowly missing the 10% threshold typically considered a correction. The index is still up 12% this year.
Mandy Xu, head of derivatives market intelligence at Cboe Global Markets, said the market’s rapid decline and rapid recovery pointed to a positioning-driven de-risking.
“What we saw on Monday (August 5) was actually separate from the stock market and the foreign exchange market. We did not see a corresponding large increase in volatility in the other asset classes, such as interest rate and credit volatility,” she said.
Investors have plenty of reason to remain nervous in the coming months. Many are awaiting U.S. data, including a consumer prices report later this week, that will show whether the economy is merely downshifting or headed for a more serious slowdown.
Political uncertainty, ranging from the US elections in November to the prospect of rising tensions in the Middle East, is also keeping investors on their toes.
Nicholas Colas, co-founder of DataTrek Research, looks to see if the VIX can stay below its long-term average of 19.5 to determine whether calm really returns to the markets.
“Until the VIX drops below 19.5 (the long-term average) for a few days, we should at least respect the market’s uncertainty and remain modest when it comes to looking for bottoms in markets or individual stocks,” he said.
WANT TO WATCH CORRECTION?
Another concern could be the fact that the market is close to correction territory. In the 28 instances where the S&P 500 came within 1.5% of confirming a correction, the index did so within 20 instances in an average period of 26 trading sessions, data dating back to 1929 showed.
However, in the eight cases where the index did not confirm a correction, the index took an average of 61 trading sessions to reach a new high.
CPI data due on August 14 and earnings from Walmart and other retailers this week could be crucial in determining investor sentiment, Mark Hackett, head of investment research at Nationwide, said in a recent note.
“It wouldn’t be surprising to see possible overreactions to this week’s CPI figure, retailer profits and investor retail sales, given the heightened emotional reactions in the market lately.”
(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Richard Chang)