The first half of 2014 was a pretty solid one for stock investors, with the benchmark S&P 500 index returning more than 6 percent over the past six months. But investors have seemed curiously unexcited about this, even though the S&P has set 22 separate new record highs this year.
There are a couple of reasons for that lack of excitement. For one, the S&P gained about 30 percent in 2013, which is a tough act to follow. For another, the market this year has been about as steady as a rock. As of the end of June, it had been nearly two months since the S&P 500 had experienced a single day in which it had moved up or down move by more than 1 percent.
In other words, this stock market has been almost entirely devoid of volatility. Professional investors keep a sharp eye on the marketís volatility, primarily through a measure known as the Chicago Board Options Exchange Volatility Index, or VIX for short. Also known as the Fear Index, the VIX is supposed to show how much the market is expected to move in the coming 30 days.
The VIX is a weighted blend of prices for a range of options that are sold on the S&P 500 index. Options give investors the right to buy or sell shares at a future date, so they can be used to calculate how much these investors expect the market to move. Since thereís a buyer and seller on either side of each option transaction, it canít tell you which direction the market is going to move. But the relative price of these options can be used to calculate implied volatility.
Volatility as determined by the VIX figure has been very low this year. It finished June at just over 11, as opposed to the long-term average of around 20. Thatís the lowest the VIX has been since February 2007, prior to the recession. The VIX did spike up above 20 for a brief moment this year, in early February, but it has been below 15 since mid-April.
It wasnít so long ago that the VIX was much higher than that. In October 2008, just after the Lehman Brothers bankruptcy, the VIX reached an all-time high near 80. And veteran investors will remember that the markets collapsed shortly thereafter, bottoming out in March 2009 before embarking on the five-year bull run we are still enjoying today.
An elevated VIX is not necessarily a sell signal, though. The VIX portends increased volatility in the stock market, which could mean increasing prices just as easily as it could mean decreasing prices. When the VIX is low, that indicates an expectation of smooth sailing ahead, which can be of comfort to nervous investors. But a high VIX means that investors are expecting changes of any kind.
The VIX often rises because of events that are external to the stock market. The last time it was above 40 was in September of 2011, during the debt-ceiling talks between the Obama Administration and the Republican-controlled House of Representatives. When that drama ended, the VIX subsided as well.
So an elevated VIX is a sign of turmoil, while a lower one is a sign that there is nothing scary on the horizon. That doesnít mean investors should expect strong market returns in the coming months Ė but it might mean fewer nervous-making ups and downs.