From Dana Lyons: Small-Cap volatility expectations are hitting new lows, yet the stocks are well below their highs — which one is right?
We’ve noted peculiar divergences between stock indices and their underlying volatility indices on several occasions this year. Of course, the two entities generally move opposite one another, with one often hitting new highs while the other is scoring new lows. Most recently, on September 8, we highlighted the fact that while the Nasdaq 100 (NDX) had just hit another 52-week high, the NDX Volatility Index (VXN) had not even registered as much as a 3-month low in more than 5 months. As we always do, we wondered which of the 2 sides in this “standoff” was correct. So far, given this week’s continued rally in the NDX, it appears that the stocks have it right. Although, just 2 days in, we’d have to say that the jury’s still out on this one.
Today’s stock vs. volatility standoff comes from the small-cap equity space. It also represents the opposite scenario than the one involving the NDX. Specifically, the Russell 2000 Small-Cap Index (RUT) is presently firmly below its 52-week high set back in July, while the Volatility Index on the Russell 2000 (RVX) hit a new 52-week low on Monday. And in fact, at 2.5% below its 52-week high, this marks the furthest the RUT has ever been away from a 52-week high on a day the RVX closed at a 52-week low outside of a few days in August 2012.
As today’s Chart Of The Day reveals, there have only been a handful of unique similar occasions when the RUT was as much as 1% away from its highs going back to the inception of the RVX in 2006.
So which one is right? Does the lower high in the RUT suggest that volatility traders are underestimating risk here? Or is the new low in volatility expectations a harbinger for an eventual new high in small-cap stocks? A few of the prior occurrences certainly came at inauspicious times for the RUT, including April 2011 and July 2015. But are those appropriate road maps to use?
In a premium post at The Lyons Share, we address these questions by taking a closer look at those previous occurrences in an attempt to come to an informed, quantitatively-backed conclusion. We also took a peek at small-cap volatility expectations from a different angle – yielding very interesting results.
The iShares Russell 2000 Index ETF (NYSE:IWM) fell $0.03 (-0.02%) in premarket trading Thursday. Year-to-date, IWM has gained 6.03%, versus a 12.95% rise in the benchmark S&P 500 index during the same period.
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Disclaimer: JLFMI’s actual investment decisions are based on our proprietary models. The conclusions based on the study in this letter may or may not be consistent with JLFMI’s actual investment posture at any given time. Additionally, the commentary provided here is for informational purposes only and should not be taken as a recommendation to invest in any specific securities or according to any specific methodologies. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.
This article is brought to you courtesy of Dana Lyons, JLFMI and My401kPro.