Falling market volatility signals growing optimism about stock rally4 min read . Updated: 28 Nov 2020, 11:12 PM IST
- The Dow soared back to a record this week, and a measure of stock-market volatility has been sliding
Market volatility is collapsing to levels not seen since February, the latest sign of optimism about a stock rally that lifted major indexes to fresh records this week.
Stocks have soared back to highs, fueled by enthusiasm about a coming vaccine for the coronavirus as well as relief that the election—widely anticipated for months—has passed. Those expectations are giving more investors confidence that social and business activity have the potential to regain some normalcy following months of lockdowns, restrictions and rising caseloads.
The Dow Jones Industrial Average rallied 2.2% this week, crossing the 30000 mark for the first time. The blue-chip index is up 13% in November, on pace for its strongest month since 1987. The S&P 500 has advanced 11% this month, while the Nasdaq Composite has jumped 12%. Both indexes closed at records Friday.
The Dow’s phenomenal run this month underscores a broadening of this year’s rally to include companies other than highflying technology stocks, giving investors some confidence that the gains could continue. Beaten-down stocks, including airlines and cruise operators, jumped higher, while the Russell 2000 index of small companies is on track for its best month on record.
“The hopefuls are leading the realists: They believe that the economy will return to an equilibrium with a high growth rate. They are looking beyond the shock," said Sebastien Galy, a macro strategist at Nordea Asset Management. “It’s a matter of time though; there are still deep underlying issues with Covid spiking in the U.S."
A measure of stock-market volatility has also been sliding. On Friday, the Cboe Volatility Index closed at its lowest level since February and briefly dipped below 20 intraday for the first time since then, before fears about the coronavirus ended the 11-year bull market for stocks. A measure of bond market volatility slid Wednesday to its lowest level since early October.
Still, the VIX bounced off its Friday low and settled at 20.84, marking its 195th consecutive trading session where it closed above 20, a streak that has been unparalleled since 2009, during the financial crisis, according to Dow Jones Market Data.
Although rising stock indexes suggest investors have been breathing a sigh of relief, the run above 20 for the VIX signals investors remain somewhat cautious and that concerns linger that the volatility that gripped markets earlier in the year could return. It also reflects elevated prices for options bets tied to the S&P 500, which investors often tap to hedge portfolios or make directional bets on stocks.
The recent stock rally has been unusual. In six out of eight of the past periods where the VIX hovered above 20 for at least 100 sessions, the S&P 500 had fallen, not risen, according to Dow Jones Market Data.
The stretch since February includes a period in which U.S. stocks tumbled into a bear market—defined as a drop of at least 20%—before rebounding back toward new highs. Since Feb. 24, the S&P 500 has gained about 13%.
“There’s still a lot of scars from what happened earlier in the year," said Chris Murphy, co-head of derivatives strategy at Susquehanna.
Some analysts said the elevated VIX has been driven by doubts about the recent stock rally, driving demand for insurance-like contracts through the end of the year to protect the recent big gains.
“There’s so much uncertainty out there," said Stuart Kaiser, head of equity derivatives research at UBS Group AG. “Nobody wants to be on the wrong side of this."
Despite positive news about the vaccine recently, it isn’t clear when it will be distributed and how quickly the economy will bounce back. Additionally, the coronavirus pandemic continues to grip the U.S., and there has been a surge of infections in the cooler months. Traders also said they are tracking the January runoff elections in Georgia, which will determine which political party controls the Senate.
The number of people hospitalized in the U.S. due to Covid-19 surpassed 90,000 for the first time. More than 110,000 new cases were reported around the nation Thursday, sharply lower than totals in recent days. But infection levels are likely to rise again because of gatherings for Thanksgiving Day celebrations.
And of course, it has been a rocky year. There have been more single-day stock moves of at least 3% for the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite—up or down—than in any year since 2008.
There are some signs that traders are positioning for the gauge to snap its streak above 20 and plummet as stocks continue to advance. Leveraged funds like hedge funds recently ramped up wagers that would pay out if the VIX fell. Commodity Futures Trading Commission data show such wagers recently hit their highest level since at least early August. Bearish bets like these on the volatility gauge are akin to bullish ones on stocks.
Volatility control funds added about $25 billion to their equity exposures through the first half of the November, coinciding with the VIX’s slide, Deutsche Bank said in a report last week. Those funds still remain about 15% below their full equity allocations, the bank added. Such funds typically make buying and selling decisions based on the level of market swings, and more placid markets can stoke more buying.
Meanwhile, there has been a flurry of bullish call options activity tied to the iShares Russell 2000 exchange-traded fund, which tracks shares of small companies. The Russell 2000 is up 21% this month, on track for its best month since its 1984 inception. Investors confident that the economy will continue to improve because of the vaccine have piled into the sector.
—Anna Hirtenstein has contributed to this article.
Write to Gunjan Banerji at Gunjan.Banerji@wsj.com and Michael Wursthorn at Michael.Wursthorn@wsj.com