Don’t Hold Your Breath, Hold Your Stocks

By TradeSmith Research Team

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Turn on any financial news network and odds are you’ll see the latest bear-infused headline.

Here’s one from Business Insider:

Wall Street’s fear gauge is crashing toward a 4-year low. That could be a sign of overconfidence, UBS says.

Sounds pretty scary, right? I imagine many investors are responding with something like this:

“The “Fear Gauge” is as low as it was… right before the pandemic, when the S&P 500 crashed 33% in one month?! A major Swiss bank is warning that investors are overconfident?! We’re done for!”

Let’s take a deep breath and see exactly what this means…

The popular CBOE Volatility Index (VIX), which measures the near-term implied volatility of the S&P 500, has dropped to multi-year lows as investor anxiety practically vanished.

Market pundits think these lows suggest “overconfidence”… and that the VIX could soon spike higher, along with a stock market crash that catches us all flat-footed.

My bet is you’ve been feeling a lot better about markets recently. After all, stocks are a stone’s throw away from all-time highs and interest rates are melting away like ice on a hot day.

Conventional wisdom may have you believe that these sunny days won’t last, and now’s the time to batten down the hatches.

HOWEVER, before you make the decision to send your stock horses out to pasture, let’s examine what history says about low-volatility regimes like now.

Today, I’ll review the landscape and put it into evidence-rich historical perspective. Then we’ll study what this means for stocks going forward.

Chances are, the results will surprise you.

Bye Bye, Market Uncertainty

No doubt about it, market volatility is low. Since the pandemic of 2020, the VIX has been on a steady decline.

Yesterday’s close of 12.07 marked a milestone: the lowest VIX close going back to Nov. 27, 2019, when the fear gauge clocked 11.75.

Source: Yahoo Finance

One look at this chart may cause unwanted heartburn considering what happened next. This four-year window gives the appearance that:

  • A low-12 reading on the VIX is rare.
  • Low VIX readings precede unwanted high volatility.
As usual, there’s more to the story.

Turns out, readings similar to now aren’t uncommon at all…

In 2018, we saw 33 days with a VIX close below 12.10…

In 2017, it happened 211 times. You might remember that as a year when stocks marched higher every single day…

And since 1990, we’ve had a whopping 868 instances when the VIX closed below 12.10.

When you look through the data, a 12.07 level just isn’t as spooky as the media wants you to believe:

Now that you have some historical perspective, hopefully you’re able to breathe a sigh of relief. Maybe the world isn’t set to end after all.

Don’t take my word for it. Let’s see the proof.

Low Volatility Means More Pain for the Bears

Despite how common it was to see a low VIX in the years before COVID, today’s environment is unique. We haven’t seen an ultra-low volatility reading in four years.

To get a sense of how stocks perform given this setup, I singled out historical instances where the VIX fell below 12.10 AND in the prior year had zero instances of a sub-12.10 reading.

Going back to 1990, it’s ONLY happened four times.

Hug a bear, because they’ll need it:

  • Whenever we see this unique setup, the S&P 500 jumps 1% on average over the next month.
  • Six months later, the market rallies 5.1%.
  • Twelve months later, stocks soar 12.1% — beating their long-term average return.

With expected double-digit gains a year from now, we should get ready for new highs in 2024.

Don’t hold your breath… hold your stocks.

After deeply oversold conditions in October, it’s only fitting that brighter days are ahead. And that creates an incredible stock-picking environment.

A new year often brings some of the best stock-picking you’ll get. Make sure you take advantage of it.


Lucas Downey,
Contributing Editor, TradeSmith Daily