Continuing with yesterday’s discussion on “Why Boring Is Good;” today we take a deeper dive into analysis which suggests the recent record low levels of the Volatility Index or “VIX” tend to be a bullish signal for U.S. equity prices over the intermediate term.
The media sometimes refer to the VIX as a fear gauge to measure investors’ expectations for future volatility in the S&P 500 Index. Higher VIX levels are generally associated with fear, while lower levels may suggest investor complacency. These interpretations, however, are not always accurate.
Over the past month, the VIX has been trending lower, reaching levels not seen since July 2014. These historically low values have some worried that investors are becoming too complacent with the recent bullish trend and should prepare for a potential trend reversal (i.e. a move lower in stocks).
Based on historical data, we do not believe this outcome is likely; in fact, going back 27 years to 1990, in each instance when the VIX closed below the 10.5 level, subsequent returns for four major US equity indexes were higher over the subsequent six- and nine-month periods, as the chart below shows:
Markets that seem boring or investor sentiment that seems overly complacent as defined by a low value of the VIX may not always translate into a bearish outcome for stocks. We may see equity volatility increase over the remainder of the year; however, our stock market forecast* remains that the S&P 500 will generate mid-to-high single digit returns with an upside bias for the remainder of the year.
*We expect mid-single-digit returns for the S&P 500 in 2017 consistent with historical mid-to-late economic cycle performance. We expect S&P 500 gains to be driven by: 1) a pickup in U.S. economic growth partially due to fiscal stimulus; 2) mid- to high-single-digit earnings gains as corporate America emerges from its year-long earnings recession; 3) an expansion in bank lending; and 4) a stable price-to-earnings ratio (PE) of 18 – 19.
The economic forecasts set forth in the presentation may not develop as predicted.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Dow Jones Industrial Average (DJIA) Index is comprised of U.S.-listed stocks of companies that produce other (nontransportation and nonutility) goods and services. The Dow Jones Industrial Averages are maintained by editors of The Wall Street Journal. While the stock selection process is somewhat subjective, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors, and accurately represents the market sectors covered by the average. The Dow Jones averages are unique in that they are price weighted; therefore, their component weightings are affected only by changes in the stocks’ prices.
The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S.-based common stocks listed on the NASDAQ stock market. The index is market-value weighted. This means that each company’s security affects the index in proportion to its market value. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index. It is not possible to invest directly in an index.
The Russell 2000 Index measures the performance of the small cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index.
Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.
The VIX is a measure of the volatility implied in the prices of options contracts for the S&P 500. It is a market-based estimate of future volatility. When sentiment reaches one extreme or the other, the market typically reverses course. While this is not necessarily predictive, it does measure the current degree of fear present in the stock market.
Indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.
The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.
This research material has been prepared by LPL Financial LLC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.
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