Rare VIX Inversion Points to Potential End of U.S. Equity Rout

(Bloomberg) -- An uncommon phenomenon in volatility markets is signaling that the U.S. equity rout may almost be over.

Monday’s slump in the S&P 500 has created the rare situation where the term structure for the Cboe Volatility Index is inverted. As the VIX surged to its highest level since October, the spot price exceeded the the March future prices, indicating more perceived risk in the immediate term rather than the longer term.

Such an inversion usually doesn’t last long and can be a sign that the sell-off may be nearing its end, according to Susquehanna’s co-head of derivatives strategy, Chris Murphy.

“Going back to 2009, the SPX is on average flat a week after an inversion,” Murphy wrote in a research note Monday, as the S&P 500 Index sank as much as 1.9% amid growing concern about the spread of the deadly coronavirus from China. “Two weeks later it is up 88 basis points on average, and one month later up 1.7%.”

Since hitting a record high on Jan. 22, the S&P has been under pressure as the coronavirus spreads, sparking a rally in the VIX spot index to its highest level since Oct. 10.

Murphy pointed out that his historical analysis captures the inversion at the close of trading, but said “even if the term structure doesn’t close inverted today, there is still to the indicator.”

Susquehanna’s derivatives strategists also assessed the parallels between the coronavirus and the SARS outbreak that roiled global markets 17 years ago.

In February 2003, both the S&P 500 and the Hang Seng Index fell about 5% in the month following the SARS outbreak, after trending lower for 30 days, U.S. indexes trended higher for the rest of the year, the strategist wrote. The Hang Seng continued lower until the end of April when the outbreak in Vietnam was declared over, the travel warning for Toronto was lifted and the SARS genome was sequenced, they noted.

They also underscored key differences, including China’s gross domestic product being a 10th of what it is today, Apple Inc. shares trading around $1 before having introduced the iPhone and the VIX trading above 30 in anticipation of the war in Iraq.

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