Decline in market volatility signals growing optimism for equities recovery

Stocks rallied to highs, fueled by excitement over an upcoming coronavirus vaccine as well as relief that the election – widely expected for months – had passed. These expectations give investors more confidence that social and business activity has the potential to return to some normalcy after months of lockdowns, restrictions and rising case numbers.

The Dow Jones Industrial Average rebounded 2.2% this week, crossing the 30,000 mark for the first time. The blue chip index rose 13% in November, on pace with its strongest month since 1987. The S&P 500 rose 11% this month, while the Nasdaq Composite jumped 12%. Both indexes closed at record highs on Friday.

The Dow’s phenomenal run this month underscores a broadening of this year’s rally to include companies beyond high-flying tech stocks, giving investors some confidence that the gains could continue. Beaten stocks, including airlines and cruise operators, surged, while the Russell 2000 Small Business Index is on course for its best month on record.

“The hopes are ahead of the realists: they believe that the economy will return to equilibrium with a high growth rate. They are looking beyond the shock,” said Sebastien Galy, macro strategist at Nordea Asset Management. “It is only a matter of time; there are still deep underlying issues with the Covid outbreak in the United States.”

A measure of stock market volatility also declined. On Friday, the Cboe Volatility Index closed at its lowest level since February and briefly fell below 20 intraday for the first time since then, before fears over 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 rebounded from its Friday low and settled at 20.84, marking its 195th consecutive trading session where it closed above 20, a streak not seen since 2009, during the financial crisis. , according to Dow Jones Market Data.

Although the rise in equity indices suggests investors have breathed a sigh of relief, the run above 20 for the VIX signals that investors remain somewhat cautious and concerns remain over the return of the volatility that gripped the markets earlier in the year. It also reflects the high prices of options bets linked to the S&P 500, which investors often use to hedge their portfolios or make directional bets on stocks.

The recent stock market rally has been unusual. In six of the last eight periods when the VIX has hovered above 20 for at least 100 sessions, the S&P 500 has fallen, not risen, according to Dow Jones Market Data.

The period since February includes a period in which US stocks fell in a bear market – defined as a drop of at least 20% – before rebounding to new highs. Since Feb. 24, the S&P 500 has gained about 13%.

“There are 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 was driven by doubts over the recent stock market rally, spurring demand for insurance-like contracts through year-end to protect recent strong 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.”

Despite positive news about the vaccine recently, it’s unclear when it will be distributed and how quickly the economy will rebound. Additionally, the coronavirus pandemic continues to grip the United States and there has been an upsurge in infections in the colder months. Traders also said they were watching January’s runoff election in Georgia, which will determine which political party controls the Senate.

The number of people hospitalized in the United States due to Covid-19 has exceeded 90,000 for the first time. More than 110,000 new cases were reported across the country on Thursday, significantly lower than the totals in recent days. But infection levels are likely to rise again due to gatherings for Thanksgiving Day celebrations.

And of course, it has been a difficult 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 signs that traders are positioning themselves for the gauge to break its streak above 20 and fall as stocks continue to rise. Leveraged funds like hedge funds have recently increased bets that would pay out if the VIX fell. Data from the Commodity Futures Trading Commission shows that these bets recently hit their highest level since at least early August. Bearish bets like these on the Volatility Gauge are akin to bullish bets on stocks.

Volatility control funds added about $25 billion to their equity exposures in the first half of November, coinciding with the VIX plunge, Deutsche Bank said in a report last week. These funds still remain about 15% below their full equity allocations, the bank added. These funds generally make buy and sell decisions based on the level of market fluctuations, and calmer markets can prompt more buying.

Meanwhile, there was a flurry of bullish activity in call options tied to the iShares Russell 2000 exchange-traded fund, which tracks small company stocks. The Russell 2000 is up 21% this month, on track for its best month since its inception in 1984. Investors convinced the economy will continue to improve thanks to the vaccine have crowded into the sector.

—Anna Hirtenstein contributed to this article.

Write to Gunjan Banerji at [email protected] and Michael Wursthorn at [email protected]

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