The S&P 500 has been experiencing historically low volatility since January 2023, sparking discussions about how long this trend can last. The VIX index, a widely recognized measure of expected market volatility, plays a significant role in this discussion. Historically, market corrections and bear markets tend to occur when the VIX exceeds 25, while levels below 20 typically support stock market rallies. However, the last year and a half has been unusually calm, with minimal volatility compared to the past decade.
When examining historical data dating back to 2007, it is apparent that the current low volatility environment is a significant anomaly. The VIX typically exceeds 25 for an average of 47 days per year, but there have only been two trading days with a reading above 25 since January 2023. Despite the expectation that highly unusual market events will eventually revert to the long-term average, anomalies can persist for longer than anticipated, making it risky to assume that average volatility will remain low indefinitely.
Recent reports indicate that the VIX has crossed above 20, coinciding with modest losses in the S&P 500. This shift in dynamics suggests the possibility of sustained volatility, potentially leading to a correction in the S&P 500. However, the likelihood of a correction entering bear market territory remains low due to macroeconomic supports such as government spending and strong economic conditions. Risks such as inflation reacceleration and geopolitical events could lead to a return to more normal levels of volatility in the market.
Prudent investors are advised to exercise caution and patience in the current market environment, refraining from adding additional risk until the direction of volatility becomes clearer. Monitoring the VIX as it crosses and sustains levels above 20 can help investors determine when to consider hedging or derisking their portfolios. The underlying factors contributing to low volatility, including the strength of the U.S. consumer and labor market, are key drivers of the current market stability, but potential events like inflation increases or geopolitical disruptions could disrupt this trend.
As the market faces a crucial juncture, strategic vigilance and prudent decision-making will be essential in navigating the uncertain terrain ahead. While the low volatility environment has been a welcome respite for investors, the possibility of a return to more normal levels of volatility should not be discounted. By staying informed, monitoring key indicators like the VIX, and being prepared to adjust strategies as needed, investors can better position themselves to weather potential market fluctuations.
