The CBOE Market Volatility Index, better known as the VIX, measures the expected volatility of the S&P 500 Index (SPX) over the next 30 days. When stocks fall, they typically move a lot faster than when they rise. When this happens, investors become nervous, and the VIX tends to rise. Alternatively, when stocks move higher, the VIX generally drops. That has not been the case lately, though. While this is a relatively rare phenomenon, the 10-day correlation between S&P 500 and VIX returns has recently turned positive. This week, I am looking at historical occurrences of this scenario to see if stocks have behaved a certain way after such unusual periods.
The chart below shows the S&P 500 and its 10-day correlation with the VIX. As you can see, this move into positive territory is the first occurrence in over a year. Next, I am going to quantify the returns following those instances to see if they lead to market weakness or a change in environment, which would be bad given the index just rallied to all-time highs.
We have VIX data going back to 1990. Since then, there have been 30 times when its correlation with the S&P 500 Index became positive. The tables below summarize the returns after those instances and show typical S&P 500 returns, for comparison.
Nothing jumps out at me as particularly notable. There is slight underperformance in the very short term, with the two-week return averaging around breakeven, and 53% of the returns positive compared to the usual return of 0.35% and 60% positive. A month after the signal, however, the tendency to underperform disappears. One thing that could be noteworthy is the reduced volatility after these events. Looking at the standard deviation of returns, stocks seem to be relatively quiet afterwards.
Of the 30 signals in which the S&P 500 and VIX were positively correlated over the previous ten days, both indexes were positive 11 times. This includes the latest signal on August 26. There are a couple of interesting observations to be drawn from the table below, which summarizes the returns after these signals. There is not much difference in index performance in the shorter-term returns, but the same cannot be said for the longer-term six-month returns. The S&P 500 Index averages a 7.46% return, with all 11 of them positive. Also, the volatility after these returns is even lower. Based on this, it would not be surprising to get an ultra-quiet market over the next few months.
Finally, in the table below, I list the dates of the 11 signals from the last table and how the S&P 500 did after each one. As mentioned earlier, stocks were positive over the next year every time. Looking at the three-month returns, the S&P has been positive after the last seven signals.