NEW YORK, N.Y. – Europe’s economy sputters, oil prices plunge and stocks start swinging wildly. Wall Street’s long dormant “fear index” now predicts more turbulence ahead.
The Chicago Board Options Exchange’s volatility index, known as the VIX, doubled over the past month: from 12 to 26. Although that’s nowhere near the 80 reached in the financial crisis, the recent spike means traders are bracing for more big jumps and steep drops.
Slowing growth in Europe and the developing world have stirred up lingering doubts among investors just as the Federal Reserve plans to wind down a bond-buying program that many considered a driving force behind the stock market’s five-year run.
Traders have knocked the Standard & Poor’s 500 index down 4 per cent this month and retreated into their hiding spots, driving up demand for some of the world’s safest investments, U.S. and German government bonds.
All of a sudden, Wall Street’s fear gauge looks relevant again.
“We’ve gone from the S&P 500 hitting all-time highs to losing all its gains for the year in just a month and a half,” said JJ Kinahan, TD Ameritrade’s chief strategist, referring to the benchmark index for U.S. stocks. “There has been a sea change in how people are viewing the market.”
The past week was especially turbulent. As markets plunged Wednesday, the VIX reached levels last seen in June 2012, when worries about the European debt crisis gripped global markets and the U.S. economy’s fitful growth kept investors on edge. By Friday, as markets rallied, it slid back to 20 — its historical average.
The index gained popularity during the financial crisis in 2008. With the global economy looking shaky, the “fear index” seemed to offer a useful look at what Wall Street insiders thought would happen next. The index is based on prices for options on the S&P 500 and measures how much traders expect the stock market will move in the next 30 days. When the stock market slumps, traders rush to take out insurance in the form of options contracts, pushing the VIX up.
“It’s like the house is on fire, so you run to an insurance agent,” Kinahan said. “The VIX shows you what people are willing to pay for insurance.”
The latest bout of jitters arrived abruptly. The U.S. stock market had been relatively calm for the bulk of the year. In July, the VIX dropped to 10, its lowest level since February 2007. Markets were so calm this summer that some days it appeared Wall Street had collectively nodded off on a beach chair. Observers called it boring.
Investors kept an eye on conflicts in the Middle East, rising tensions between the U.S. and Russia and other worrisome news. But as long as interest rates stayed low and companies kept hiring more workers, none of it sapped their confidence in the stock market.
Things started to change in late September as reports began piling up that Germany’s economy, the largest in Europe, was close to a recession. Economists warned of a global slowdown. Major markets in Europe tanked and the U.S. stock market began its slide.
The market’s mood swings can make for a wild ride. Take Wednesday. The S&P 500 plunged more than 1 per cent in the opening minutes of trading following news of a drop in retail sales in the U.S. and more turmoil in Europe’s markets. But within an hour, it pulled the first in a number of U-turns. The stock index bounced back to its starting point, then dove more than 2 per cent by the afternoon. It was shaping up to be the worst one-day loss this year.
As the closing bell neared, the market made one more turn, heading higher to end a tumultuous Wednesday with a loss of just 0.8 per cent.
Another volatile element in the mix: high-frequency trading by computer programs, which some believe may have amplified Wednesday’s moves. Computer programs now dominate stock-market trading, instantly picking up news on social media and other signals, leading to selling and buying more rapid and intense than any human could pull off.
The day after, money managers, bankers and others in the financial markets tried to explain how greed could turn to fear so quickly. Many said the slight change in economic numbers couldn’t fully account for the recent turmoil. The U.S. economy still looks steady, and corporations have started turning in stronger third-quarter profits.
Harvey Schwartz, Goldman Sachs’s chief financial officer, told analysts on a conference call that “nothing has fundamentally changed in the past few weeks or certainly the last 24 hours.” The market’s mood swings remind “all of us about the power of investor sentiment and how fragile it can be at times,” he said.