The traditional relationship between the Volatility Index ($VIX) and the S&P 500 is an inverse one. The best method to illustrate that is to drag up a chart displaying each and their correlation coefficient:

The pink arrows mark bottoms within the S&P 500 they usually typically coincide nearly completely with tops within the Volatility Index. Within the backside panel, the correlation coefficient tells us whether or not the SPX and VIX are transferring in the identical course (constructive correlation) or in the wrong way (inverse or unfavourable correlation). The latter is highlighted by the blue-shaded space. It ought to be pretty apparent that the VIX and SPX nearly at all times transfer in reverse instructions.

To totally perceive the VIX, you want to have a primary understanding of inventory choices and the way they work and are priced. Choices are contracts that give choice patrons the proper to purchase or promote a inventory at a predetermined worth (strike worth) on or earlier than a specified day (expiration day). The pricing of choices depends on plenty of components, however two of an important are the volatility of the person inventory and the time remaining on the contract.

The worth of the VIX relies on the “anticipated volatility” of the S&P 500 over the following month. As I identified within the chart above, the VIX usually goes up when the S&P 500 goes down (inverse correlation, keep in mind the blue-shaded space). That tells us that anticipated volatility will probably be greater throughout market downtrends. And, as a result of the VIX relies upon anticipated volatility over the following month, the decrease the VIX goes, the extra bullish the sign for the S&P 500. The largest strikes greater within the S&P 500 have traditionally occurred when the VIX is dropping and prolonged bull markets are related to historically-low VIX readings.

After I take a look at sentiment, I solely like two indicators. One is the VIX, as a result of it seems at how market makers are pricing S&P choices, which gives us a clue as to what market makers predict over the following month. The second is the equity-only put-call ratio ($CPCE), as a result of it gives us a really feel for the psyche of the retail dealer. The latter is the very best contrarian indicator within the inventory market, for my part. Its predictive talents are astounding. However let’s persist with the VIX right here for this text.

Bear markets require plenty of issues, however one vital want is worry. The extra worry we now have, the extra unstable the inventory market is, and the upper the VIX. That is the way it works. That is why we see VIX readings within the 30s, 40s, and 50s at or close to the underside of bear markets. In 2008, throughout the peak of the monetary disaster, the VIX spiked to 90! On the different finish of the spectrum, nevertheless, are bull markets that see the VIX tumble all the way in which again to single digits.

So the place are we now? Nicely, this is what historical past tells us. When the VIX drops beneath 16-17, we’re OUT of the present bear market and we must always count on greater costs. The underside’s already been made and the falling VIX confirms the worst is behind us. Let’s take a look at charts to see what I imply:

2020 Pandemic

Bear market led to March 2020. VIX later reached beneath 16-17 stage in June 2021. Affirmation.

2018 Commerce Struggle

Do you see the rallies in November and December 2019? Observe that they occurred after the VIX bottomed within the 16s. The February 2019 drop within the VIX beneath 16 confirmed a backside was in.

2007-2009 Monetary Disaster

This was not your regular bear market. First, it was the deepest bear market in practically 8 a long time, with the S&P 500 falling practically 60%. There have been “echoes” of worry for fairly a while because the VIX remained elevated above 16 for an prolonged interval. However as soon as the VIX fell beneath 16, the depths of the bear market had already been reached.

2000-2002 Dot Com Bubble

1998 World Monetary Disaster

The late-Nineties was one of many craziest market runs in inventory market historical past. It is also the one secular bull market interval characterised by VIX readings constantly above 16. The very best secular bull market in historical past (Nineteen Eighties-Nineties) noticed “irrational exuberance” on the finish that led to the beginning of the 2000-2012 secular bear market.

1990 Persian Gulf Struggle

This was a short-lived cyclical bear market that ended nearly as shortly because it started.

So the place are we now? What ought to we count on transferring ahead?

2022 Return of Inflation

Are we firstly of the secular bull market resumption – the one which started in 2013? Or has this rally set us up for extra promoting and a decrease backside forward in a secular bear market?

Two nice questions the place most market individuals have been firmly planted on one facet or the opposite. Personally, I used to be searching for a cyclical bear market when 2022 started. I regarded for a 2022 backside after which an ensuing rally to all-time highs. Up to now, so good. Nothing has modified my view. Cash has rotated feverishly in 2023 to “threat on” areas of the inventory market:

The inventory market is rising and being led by aggressive sectors. That is really an indication of sustainability, for my part, and based mostly on my a few years of analysis.

Oh, and I might LOVE to argue valuation proper now with anybody. Actually, my EB Digest article tomorrow morning will reveal why I imagine present market valuations are WAAAAY low and we’re poised for an enormous rally over the following decade. If you would like to learn this text and aren’t already an EB Digest subscriber, CLICK HERE to enter your title and e-mail deal with. It is fully free and it’s possible you’ll unsubscribe at any time.

Completely satisfied buying and selling!

Tom