The S&P 500 has rallied over 10% since the February low, push the index up to its 50-week Moving Average. Meanwhile the Volatility Index ($VIX) has declined approx. 47%, sending the ‘fear index’ to its lowest level so far this year.
One way to use Moving Averages besides in terms of trend identification and areas of support and resistance is measuring how far a security or market is from its specified average price. Currently the $VIX is the furthest it’s been from its 50-day MA since the prior lower high in the S&P 500 back in October 2015. As the chart below shows, it’s now more than one standard deviation below the mean based on the distance Volatility historically travels away from its 50-day.
Previous instances of the VIX falling this quickly has led to tough market conditions in the short-term for equities. As I mentioned on Twitter yesterday, the $VIX is also near its 200-week Moving Average, which has been an important level in the past. Steve Deppe also shared on Twitter that when the VIX that since 1990 when the index’s 20-day return is less than -30%, the average forward return for the S&P 500 over the next 5, 10, 20, and 40 days has been negative.
It’s important to remember that there are two ways that Volatility can correct it’s current stretched condition – time and price. We could see VIX move sideways and remain near 15, allowing its 50-day MA to ‘catch up’ or we could see a bounce sending Volatility higher. We obviously can’t know which option will occur, but it does seem that some form of mean-reversion needs to occur – whether it be via time or a large price movement.
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