The chart shows the Chicago Board Options Exchange’s volatility index or VIX (red line) versus the S&P 500 Index (blue line) for the year to date. The VIX measures investors’ expectations of how far the S&P 500 is likely to rise or fall over the next 30 days.
As you can see, the VIX is inversely related to the stock market. It goes up when the market crashes (investors are scared), and falls when the market rises (investors are confident). That’s why it earned its nickname of the ‘fear index’.
VIX’s recent decline means investors see less risk of a drop in stocks
The VIX has fallen significantly from its January highs of 57 (circled), recently standing at 35.3. That’s a 38% drop, showing less fear of another big fall in stocks.
You can see how the VIX has stayed above 40 for most of the year so far. But then in mid-March the ‘fear index’ finally broke lower.
This decline shows a shift in investor psychology. Investors are moving back into the market for a number of possible reasons. First, they may perceive governments’ efforts to stem the crisis are working. Second, they could be attracted by the positive surprises we’ve seen in first-quarter corporate earnings. And third, perhaps they are cheered by signs that consumer spending is increasing.
Whatever the reason, so long as the VIX keeps on heading down, then stock markets should remain stable. But if you see the fear index heading back above 40, it’s time to take cover.
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