Tranquil markets aren’t considered bullish, but this year proves otherwise
In a surprising turn of events, the tranquility of the markets has not been a bearish sign as traditionally believed. Despite the VIX – the CBOE Volatility Index – hitting record lows, the stock market has continued to climb, defying contrarian expectations.
Last December, the VIX fell to its lowest level since 2019, indicating a high level of bullish complacency. However, the stock market has since surged by 13.3%, as measured by the Wilshire 5000 Total Return Index. Even now, with the VIX only slightly higher than last December, the market continues to perform well.
Research conducted by finance professors Alan Moreira of the University of Rochester and Tyler Muir of UCLA has shed light on this phenomenon. Their market-timing model suggests that the stock market tends to perform better with less risk when the VIX is low. By increasing equity exposure as the VIX declines, investors can potentially capitalize on this trend.
The professors’ model has been proven to outperform the market by producing better returns relative to the volatility it incurs. While the contrarians may argue that the market performs well when the VIX is high, they fail to consider the extreme volatility that comes with it, resulting in a lower return-to-volatility ratio.
Investors are advised to pay attention to the VIX as a short-term indicator, but not to jump the gun prematurely. The market can remain calm for extended periods, and it is essential to give it the benefit of the doubt until the VIX shows significant movement.
As Mark Hulbert points out, the current market conditions challenge conventional wisdom, and investors should consider the implications of a low VIX on their investment strategy. With the right approach, investors can navigate the markets successfully, even in times of unexpected tranquility.
