Editor’s note: This article was first published in April 2013. The market situation described is as of then: nine months of low volatility, the S&P 500 at record highs, VIX call activity at a three-year high, S&P 500 targets of 1,350 and 1,267 points, and an IBEX 35 scenario of 7,200 points.
The prolonged absence of volatility in the markets is not necessarily a good thing: the last time the VIX (Volatility Index) was at this level was shortly before the collapse of Lehman Brothers. We all know what happened next.
After nine flat months, during which investor optimism pushed the S&P 500 to record highs, there are already signs that instability is returning. According to CNBC, call options on the VIX have hit their highest level in three years, which suggests that bullish sentiment on the S&P 500 is running out. Ryan Detrick, an analyst at Schaeffer’s Investment Research, says that, although we may not like to hear it, this rise in VIX calls comes just before a significant pullback.
He points out that the last time call option activity on the VIX reached this level, on 13 January 2010, the market lost 9% in just four weeks, mainly because of worries about the European debt crisis.
Ryan Detrick says the fears about Europe are back, joking that they tend to crop up in spring, and if we add that to the other signal, what we saw in the past is likely to happen again.
Abigail Doolittle, a technical analyst at the Seaport Group, also said she sees a very ugly pattern that could herald a very difficult period for the stock markets.
How far could this rise in volatility take us?
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The S&P 500 could test the 1,350 zone, which would be a 12% drop from current levels, or even the 1,267 zone, a drop of 18%. And even in the best case, they all but take for granted that we will see a fall of at least 9% in the S&P 500.
In this context, for our IBEX 35 we would stick with the three possible scenarios we set out at the end of our article We need to be bearish on the markets, the most likely being that we see 7,200 points, without ruling out (let’s hope not) even lower levels.
Our colleague Victoria Bernal, who has been warning us for some time that something is wrong, keeps saying that something does not add up in the markets and that analysts and governments are talking as if the worst were already behind us, when there is some chance that the worst is yet to come. She again recommends that, at least for now, it would be better to stay out of the stock market or to trade against it, since it would be much easier to know where to place our stop-losses if we go bearish.
Featured image: McKnight Buchanan, CC BY-SA 4.0, via Wikimedia Commons.
