Falling VIX Can Unlock Higher Levels for S&P 500, Evercore Says

(Bloomberg) -- Stock volatility is dropping toward levels that could further encourage U.S. equity bulls even as warnings about complacency continue to hang over the rally from March’s lows.

The Cboe Volatility Index, a measure of implied equity swings, is now one-third the level reached at the height of the Covid-19 market uncertainty. A move lower would be a bullish sign for U.S. stocks, according to Evercore ISI. But Mizuho Bank Ltd. says it’s also possible investors don’t fully appreciate the chances of sharp swings in markets awash with stimulus.

The VIX, or “fear gauge” as it’s often called, closed Monday at 27.9, higher than its lifetime average of 19.4 but well below a peak in mid-March above 82. A fall to 26 would be “huge for risk and a break below that level will unlock the door to 3,500 on the S&P,” Evercore technical strategist Rich Ross wrote in a July 6 note.

The S&P 500 is on a five-day winning streak and closed 1.6% higher Monday just below 3,180.

While Tallbacken Capital Advisors LLC’s Michael Purves says near-term implied volatility could fall further, he is taking profits on a short position in July VIX futures as earnings season approaches.

“Prospectively, there is a good chance the July contract will see its market price decline in the coming days, especially in this week after a long holiday, but before earnings season gets going,” he wrote in a note.

The fear gauge’s decline, along with tightening spreads in high-yield credit and a “mellower” U.S. dollar, may have dulled the “sense of perceived volatility,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank in Singapore. The risk of an abrupt spike in volatility is potentially underappreciated, he added.

Not everyone sees the decline in VIX as positive, particularly if it points to complacency over risks such as an upsurge in coronavirus cases, an uncertain earnings season and the U.S. election later in the year.

“And therein lies danger -- of silent volatility, surreptitiously building up in many interconnected corners of the financial and asset markets that are awash with stimulus money,” Varathan said.

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