Are recession fears exaggerated? Equity Investor Behavior Not Outright Panic, Strategists Say

Despite all the pain that has accumulated in the US stock market, one thing has been surprisingly rare: fear.

Virtually every corner of Wall Street is rocked by fears that rising interest rates could drive the economy into a recession, causing wild price swings in everything from junk bonds to foreign currencies. But the CBOE Volatility Index, the so-called fear gauge of stock market sentiment, remains well below levels seen in past bear markets.

Options strategists and bankers cite a simple reason: The S&P 500 has staged a long, orderly descent from hitting record highs earlier this year as the Federal Reserve pulls back its flood of stimulus in the age of the pandemic. This differs from crashes caused by shocks like those caused by Covid-19 in March 2020 or the collapse of Lehman Brothers Holdings Inc. in September 2008, both of which sent the VIX higher as investors sought to hedge the risk of wild swings in the market.

“Negative sentiment dominates the conversation as bull market excesses are weeded out,” wrote Lewis Grant, senior portfolio manager at Federated Hermes, in a note. “Still, the VIX index is only marginally higher. For equities at least, this is an orderly bear market rather than outright panic.”

In fact, this year the VIX has not broken above the key level of 40, which many experts consider to be a peak fear signal. It reached double that level at the start of the pandemic and during the 2008 credit crisis.

Today’s market is more like the one after the dot-com meltdown, another period in which stock valuations fell from what many considered unsustainable highs. The VIX is currently implying a 2% daily move in the S&P 500, according to Talal Dehbi, senior sales and quantitative strategist at PrismFP.

“The current behavior is playing out similarly to the dot-com bear market of 2000-2002, with no big sudden shocks but with high and sustained realized volatility,” he said.

As a result, traders do not rush to volatility hedges. Take the bias, which measures the relative cost of hedging against a one standard deviation decline in the S&P 500. Its cost hovers around June 2019 levels.

Marginalized concerns about volatility may also reflect another element of the stock market’s slide. As deep as it has been, with the S&P 500 down 18% this year, the causes are well known: tighter monetary policy and runaway inflation. The main question is when did these two loosen enough to allow the market to rally.

The S&P 500 rebounded more than 3% on Friday, the biggest gain since May 2020, after a reading on inflation expectations eased and a Fed official suggested recession fears were overblown.

“Not enough investors panicked and bought short-term protection puts, which would push the VIX index much higher,” said Edmund Shing, chief investment officer of BNP Paribas Wealth Management.

There are few signs that this is changing. The VVIX index – which measures the implied volatility of options on the volatility index – is hovering below 100 and recently hit its lowest since January 2020. This means traders are expecting smoother sailing for l VIX index.

This makes stocks relatively unique. An indicator of expected volatility in the Treasury market, the ICE BofA MOVE Index, is hovering near the highs reached at the height of the March 2020 selloff. The same is true for the JPMorgan Global FX Volatility Index.

“Inflation, Fed policy and interest rates are at the heart of market risk. So the MOVE is exceptionally high,” said Dean Curnutt of Macro Risk Advisors, citing the divergence in bond volatility and shares.

BNP’s Shing said he was surprised the VIX hadn’t risen in line with measures of business risk, such as the cost of credit default swaps protecting against default, which has risen sharply this year.

In recent bear markets, the VIX has typically hit 45 before the S&P 500 hit bottom. That’s about where it peaked in 2002, which marked the bottom of the dot-com bust. On Friday, it ended around 27, down on the day.

This story was published from a news feed with no text edits. Only the title has been changed.

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