Volatility on the rise as markets tumble
Stocks throughout the US and Europe have reversed lower as a resurgence in Covid cases sparks fears of another bout of nationwide lockdowns. That topics is unlikely to go away, with Germany and France potentially set to announce a tightening of restrictions today.
With the US election due next week, there is little surprise that the so-called ‘fear gauge’ has pushed sharply higher over the course of the week. The Volatiltiy Index (VIX) is typically negatively correlated with the S&P 500, with the brevity of the previous pullbacks ensuring that the VIX rebounds were similarly limited.
However, there is a fear that this current period of stock market weakness could be more protracted than any seen since the March lows in global markets. As such, there is a possibility we could see the VIX run higher over the near term as market pessimism continues to take hold.
Near-term resistance comes in the form of the 34.80 swing high from early October, with a push above that level paving the way for a move towards the hugely significant 39.60. Looking at the VIX over the course of the past six months, that 40.00 region appears to be a major hurdle where the index feels relatively stretched.
Above that point we are looking at a position where many will attracted to potentially look for longer-term short positions on the presumption that normality will resume soon enough. There is no guarantee that we will reach the 40.00 level, with hopes of a vaccine breakthrough and US stimulus package potentially quelling the current negative sentiment that permeates markets.
Nevertheless, with the possibility of a huge swathe of Europe being locked, the economic recovery soon turns into a double-dip recession.
While some point towards the US election uncertainty being a significant driver of an elevated VIX, the negative correlation between stocks and the volatility index does highlight that whatever is causing this market selloff is responsible for the VIX rise.
Given the fact that the lockdowns we are currently seeing are predominantly in Europe, it makes sense to look for specific weakness in European stocks. As such, the EU Volatility Index (EU VIX) if of particular interest here. The break through 30.00 highlights how this rebound is more advanced than the VIX.
With the index having consolidated throughout recent months, there is a chance we could be in for a bullish breakout should market weakness persist. Once again, the 40.00 region looks like long term value for shorts. However, until that happens, the potential for a period of downside does make the EU VIX an interesting long position over the short term.