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  • by Clint Cowles, CMT

What’s happening in stocks? Let’s ask volatility.

We’ve been hearing a lot about the CBOE Volatility Index (VIX) lately and how volatility is back in the stock market for 2018. That’s true to an extent, but is there enough fear in this market to tip the scales and bring back the bear? Let’s look at how its played out in the past.

Below is a chart from July 1, 2015 through December 31, 2016 of the S&P 500 (SPX) (top) and VIX (bottom). This was the last time VIX closed above 20. The first spike in VIX in August 2015 was caused by the market drop at the same time. SPX and VIX are inversely correlated so that makes sense, but what stands out is the lack of strength on its second spike.

In early 2016 SPX dropped to a lower level than it did in 2015, however VIX stopped 25%  short of its previous spike. From there, SPX started a rally that would last two years. There were some smaller pullbacks in SPX through that time, but each pullback corresponded with a lower VIX price.

Source – thinkpipes© Platform

We’re seeing a similar pattern emerge today. Here we have the same chart from January 1, 2018 to the present.

SPX is trending sideways within a consolidating triangle pattern, characterized by higher lows and lower highs. If we look at the high points in the VIX corresponding to the lows in SPX, we see that each VIX spike is lower than the one before it. This is showing that even though an uptrend in SPX has not established in the last three months, the fear that it will turn bearish is subsiding, thus leading to a higher probability that this triangle breaks up instead of down.

Source – thinkpipes© Platform

At some point the bear will return  and the relationship between SPX and VIX will be an important analysis next time we experience higher volatility.

The last chart depicts the beginning of the last bear market, April 1, 2007 – April 1, 2008. The VIX spike correlating with the low in SPX on November 23 is a key signal. The low in SPX comes to the same price as it did in August, and the VIX spike also comes to the same level. This is the major difference between heading into a bear market, and a pause in a greater bull market.

Source – thinkpipes© Platform

SPX has had more volatility in 2018 than it has in over two years, however it has seemed to be short lived. VIX has been drifting lower since its initial spike in early February, showing a reduced fear of SPX breaking lower and entering a bear market.

Next time we see a VIX close above 20, watch for the second spike. If its higher than the first, there may be larger concerns at hand.

TD Ameritrade Institutional, Division of TD Ameritrade, Inc., member FINRA/ SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.


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