Fear Index Hits Multi-Year Low

Are investors too comfortable with the long-running run in stocks...?

 

LET ME begin by first stating this, writes George Leong at Investment Contrarians.

 

I'm not going to talk about the Federal Reserve in any detail, or about the holiday shopping season and how it's so important to the retail sector and the economy because these don't seem to be of any great concern to the markets.

 

The reality is that both traders and investors appear to be really comfortable at this moment with the record-high levels in the stock market. Take a look at the multiple records recently set by the S&P 500 and Dow Jones Industrial Average; you won't see any sign of a pullback. Yet no one seems to care – even though this is all incredibly dangerous for the stock market.

 

This is simply not a normal trading environment for the stock market, since the Federal Reserve has largely been responsible for the record advances, as I previously discussed in this column on Friday.

 

A look at the CBOE Volatility Index (VIX), or the "fear index," reveals the current multiyear low in the VIX, which we haven't seen since 2007, prior to the subprime mortgage-driven stock market correction in 2008, The current low level of the VIX suggests that the stock market is relaxed and is not expecting any strong moves in either direction on the horizon. Looks like the market could be in for a surprise in the New Year.

 

Are traders simply too relaxed? The chart of the VIX below shows the big gaps between the VIX readings and the S&P 500.

 

In 2007, the VIX reading was below 10, but the S&P 500 didn't begin to sell off until the VIX increased to the 30 level, which indicated expected volatility. The recent low point for the S&P 500 surfaced in early 2009 when the VIX skyrocketed to the 80 level. Since then, the VIX has been steadily declining and the S&P 500 has been edging higher.

 

Take a look at the major gap between the VIX and the S&P 500 as shown by the oval in the chart below. As long as the VIX moves lower or holds at its current level, it's likely the S&P 500will keep moving higher.

 

This is where we are at the moment.

 

The VIX is at a low, suggesting there could be more gains to come. If the VIX begins to edge higher, it could signal some upcoming selling pressure for the stock market. If this happens, then it would be wise to start liquidating some of your long positions; albeit, it's always a good time to take some profits, especially as we near the end of the tax year.

 

The VIX as a stock market indicator may not be perfect or even offer a sure bet, but investors still need to monitor the index to help form an investment strategy for your assets should stock market volatility pick up.