VIX Futures: Fall Below 26-27 Would Be Bullish for Stocks
A hedge fund portfolio manager highlighted an interesting observation to me this week that I believe investors should be paying close attention to as markets transition through this historically volatile time of the year. To be clear, I am not an option or volatility expert but the chart below is noteworthy from a technical perspective and is likely to provide an important signal for equity markets in the coming months.
The top panel of this week’s chart is the 7-month volatility (VIX) futures contract (March 2021). The relatively high level of this contract at 27 shows that investors remain worried about equity markets into Q1 2021.
What I find interesting is that a similar technical set up was in place heading into the fall of 2012 which also happened to be an election year. I remember that time frame well and a lot of the clients I was speaking with at that time were very worried about a variety of issues facing the market: notably the economy, Brexit and the election. So, in hindsight, it wasn’t that surprising many investors were paying up for option protection for the upcoming 2 quarters.
In many ways, the option market today reflects the same uncertainty looking forward over the coming 2 quarters. What’s going to happen with COVID, the economy and the implications of the upcoming election are all understandable concerns. However, in 2012, despite all the worries that were being priced in to protect portfolios through options, the decline below the 26-27 support level signaled an important bullish upside reacceleration for the stock market. 2016 had a similar set up, albeit from lower levels, where volatility futures remained elevated heading into that election then fell dramatically and stocks rallied strong into 2018.
I believe a similar set up is in place today with so many investors understandably positioned for more volatility and uncertainty. Of course, no one knows how this will resolve into Q4.
Bottom line: A bullish signal will flash for equity markets should those forward VIX futures fall below 26-27. As one seasoned portfolio manager regular reminds, trade what you see (VIX futures falling below 26-27) not what you think (headlines).
Figure: Weekly Sector Review
Source: FSInsight, FactSet
Figure: Best and worst performance sectors over past 3 months
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