Last week the VIX traded to its lowest level since before the 2008 financial crisis. This makes sense given the extreme inverse correlation between the S&P500 and the VIX. As a result, SPX is at its highest levels in over 3 years. The question though is if the VIX is going to stay this low, how will that impact SPX?
Because the VIX measures volatility, the fact it is multi year lows means volatility is very low. When you have low volatility wide daily trade ranges become rarer and rarer. We got a taste of what the new normal for the market could be like on Friday when SPX traded in its most narrow range so far in 2012 (1,401-1,405). Further evidence that the ranges could become tighter and tighter was the fact that the VIX declined 6% Friday.
Typically a 6% move lower in the VIX would coincide with a pretty explosive move higher for SPX. That wasn’t the case though and we believe the reason is that the VIX is now so low that it will be harder for the inverse correlation to play out. As a result, we should see the uptrend that has been in place since October become less aggressive. We should also note that when the VIX has been around these levels in the last 3 years, it has tended to precede a period of weakness for SPX.
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