You’re probably familiar with the VIX, the S&P 500 Volatility Index. It is commonly referred to by the moniker, “fear gauge”, which theoretically is a bit of a misnomer. The VIX is merely a measure of traders’ expectations of pure volatility in the S&P 500 over the next 30 days, not necessarily downside risk. However, in practice, “fear gauge” is not that inappropriate when it comes to equity volatility indices.
Volatility indices on other asset classes are typically true measures of strict volatility. In the equity market, there is a stronger correlation between directional movements in volatility indices and equity indices. Specifically, volatility indices generally rise as the underlying equity index drops, and vice versa. Therefore, it is not completely off base to suggest that elevated equity volatility indices are a sign of investor fear, while depressed levels are a sign of investor complacency. If that is indeed accurate, the NASDAQ 100 has never engendered more complacency than right now.
We say that because the Volatility Index on the NASDAQ 100, or VXN, closed at 11.19 on March 13, an all-time low since its inception in 2001.
So does this mean that the NDX is at risk of a significant selloff? Yes. However – and this is what many market observers get wrong – the low VXN does not mean that a selloff is imminent or assured. It merely marks a condition in which a selloff is an elevated risk. Low volatility readings can, and usually do, persist for some time prior to any significant stock market damage.
With that said, volatility indices have already been low for quite some time. Furthermore, an all-time low VXN reading is not your average, everyday subdued volatility reading. Thus, our qualitative sense is that traders are indeed getting a little too comfortable in NASDAQ 100 stocks – and that makes us a bit uncomfortable.
The PowerShares QQQ ETF (NASDAQ:QQQ) rose $0.22 (+0.17%) in premarket trading Wednesday. Year-to-date, QQQ has gained 10.81%, versus a 5.98% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Dana Lyons, JLFMI and My401kPro.