Wall Street’s famous fear gauge is sending worrying messages to US stock bulls, betraying growing anxiety in the volatility market over rising tensions in the Middle East and ongoing turbulence in the bond world.
While the S&P 500 Index’s declines this week have appeared largely orderly, the nearest futures contracts tied to the Cboe Volatility Index — also known as the VIX and a measure of expected swings in America’s benchmark equity gauge — closed Thursday in a pattern known as backwardation. It’s a telltale sign of mounting distress, as traders anticipate more volatility in the near-term than further out in the future.
Almost all stock-market troughs in the past have occurred during periods of backwardation.
Typically the VIX futures curve slopes upward, known as contango, reflecting that the outlook for the S&P 500 becomes less certain as the time horizon stretches. That has been the case for most of this year, as Thursday’s session ended the longest streak on record of the front-month future trading below the second-month, according to data compiled by Bloomberg. The flip comes less than three weeks after the VIX spot level briefly moved above three-month contracts.
“We’re finally seeing the demand for short-term protection exceed the amount of volatility that’s available in the market,” said Steve Sosnick, chief strategist at Interactive Brokers. “There’s this realization that we’ve had a quiet market for some time, but things are changing.”
The signal comes amid worries that Israel’s war with Hamas will spark a bigger conflict in the energy-producing Middle East, with the US saying its military bases in Iraq and Syria are increasingly under attack. At the same time, volatility has been rampant in the bond market as policymakers wrestle high inflation and American borrowing soars.
The S&P 500 Index fell 0.9% Thursday, its third straight day of declines. The VIX Index itself closed at 21.4 — far from levels usually associated with major equity selloffs, but above the psychologically important 20 level. It had closed below that for 105 consecutive days, the longest stretch since 2018.
The good news for bulls is it’s a mild inversion for now. And while backwardation has been present in most stock routs, it’s been more of a necessary and less of a sufficient condition to predict S&P 500 troughs. This time in 2022, the VIX backwardation marked the lowest point for the index, and in June of that year it preceded a major rebound.
Still, it ends a lengthy spell when traders priced the greatest risks as being further into the future. The front- and second-month VIX contracts — the most widely followed variants of the VIX — remained in contango all through the banking tumult in March and market turmoil in September.
November VIX futures — the front-month contract following the expiration of October VIX futures on Wednesday — settled at 20.555 on Thursday, or 0.007 points above the December contract that closed at 20.548.
This article was provided by Bloomberg News.
