U.S. Fear Gauge Slides, But Market Reality May Spur Resurgence

(Bloomberg) -- Wall Street’s “fear gauge” is defying the recent market swoon.

The Cboe Volatility Index, known as the VIX, has fallen eight of the past 10 trading sessions, closing at 19.98 on Wednesday compared with 36.07 on Dec. 24. That’s at odds with large realized swings in U.S. stocks -- a potentially unsustainable divergence.

U.S. Fear Gauge Slides, But Market Reality May Spur Resurgence

“Market internals imply a VIX of 31 based on trailing realized volatility and five-day SPX returns,” UBS Group AG strategist Stuart Kaiser wrote in a note about the gauge’s fair value. “60-day realized volatility above 25 percent is the largest driver of that estimate.”

With big down days for the stock market likely, the sizable gap between implied and historic price swings may be untenable, according to Wells Fargo & Co. strategist Pravit Chintawongvanich.

“Historically, when VIX diverges this much from realized vol, it usually ‘catches up’ sometime in the next month,” he wrote in a note Wednesday. “The VIX has dropped rapidly as the market rallies, despite high realized volatility. The VIX at 20 is 10 points below one-month realized vol of 30.”

Still, a more-dovish U.S. monetary stance, easing trade tensions and improved liquidity compared to late 2018 may justify lower premiums for equity price swings, Chintawongvanich concludes.

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