Since the coronavirus first captured financial market’s attention on January 17th the S&P 500 is up 1.7% but the CBOE VIX Index is also higher by 19%. That is unusual, for the VIX and stock market returns are usually negatively correlated; declines in the “Fear Index” typically coincide with equity rallies and vice versa.
What’s dragging the VIX higher, and should we worry about it? Every month we look at the Implied Volatilities imbedded in options tied to exchange traded funds that track S&P sectors. Those give us a good sense of the underlying causes of shifts in the VIX, which of course measures near-term expected volatility in the S&P 500. The VIX itself is the Implied Volatility of options on futures contracts tied to the index, so we’re comparing (mostly) apples to apples except for maturities (VIX is 30 days out, our sector IVs are across all expirations).
Here’s what we see from looking at changes in sector Implied Volatilities, starting with the largest contributors to the increase in the VIX over the last month:
- Consumer Staples, with a 53% increase in Implied Volatility. These spiked from very low levels (7.1%) right before the coronavirus became front-page news to 10.9% today. The group has underperformed the S&P 500 in the last month, and heavyweight names (PG, WMT) underwhelmed on their Q4 earnings announcements.
- Materials and Energy, with 32% and 27% increases in their IVs. No explanation needed here; these groups have been hard hit by reduced economic activity in China.
- Industrials, where Implied Vols have risen by 23%. The group is basically flat since mid-January but worries over the Chinese/global economy have taken a toll on investor confidence.
Conversely, here are the important groups with monthly changes in their IVs that are below the increase in the VIX (that 19% we mentioned up top) and the aggregate of all options expirations (+27%, as shown in the chart above):
- Technology, with just a 13% increase in Implied Volatility. As with Energy and Materials, it is easy to see the relationship between performance (in this case excellent) and demand for options hedging and resultantly higher Implied Vols.
- Financials, with a 17% increase in that group’s “VIX”. Aside from 2 sharp drops late last month, the group has gone nowhere in 30 days. Historical volatility is an anchor for markets to forecast future price churn, so while the IVs of Financials may be up modestly they clearly are not an important driver of higher expected market volatility.
- Consumer Discretionary, where the 30-day change in Implied Volatility is actually negative 1%. That’s because Amazon is 26% of this sector and the stock is up 16% since mid-January on a good Q4 financial report.
- Health Care, with just a 5% increase in its “VIX”. Another loser over the last month, but more exposed to US political developments than the coronavirus.
The upshot to all this: in terms of sectors it is mostly Staples, Materials, Energy and Industrials (22% of the S&P 500) that have tugged the CBOE VIX Index higher over the last month. Other more systematically important groups – Tech, Financials, Health Care and Discretionary (60% of the S&P) – show smaller increases in their individual “VIX” levels. Layer on some higher levels of sector correlations to the index, common during volatility, and you have a reasonable picture of why the VIX has gone up in the last month.
While that may seem comforting, there’s a thorn in this rose: markets are actually more complacent than today’s 14-handle VIX signals. Implied volatilities have risen dramatically for only the clearest losers (Industrials, Energy and Materials) or structural laggards (Staples). Other key sectors, be they near term winners (Tech) or not (the other groups mentioned above), show little sign of investor concern over future macro developments from the coronavirus. We continue to like US stocks, but fully recognize markets have drained the half-full glass and are asking for another round.