Is fear due for a comeback?.
Wall Street’s so-called fear gauge bounced off a 23-year low on Friday as a selloff in tech stocks spooked investors.
A steep drop in the Nasdaq Composite Index COMP, -1.80% triggered by slump in high-profile tech names, sparked volatility in a market that had remained composed even in the wake of the failure of U.K. Prime Minister Theresa May’s Conservative Party to maintain a majority in parliament and former FBI Director James Comey’s Senate testimony.
The CBOE Volatility Index VIX, +5.31% a measure of the market’s expectation for volatility over the coming 30 days, jumped 11% to 11.29, after earlier sliding to 9.37, a level not seen since December 1993.
But despite the subdued VIX, another important measure of sentiment indicates that not all investors are oblivious to a plethora of uncertainty surrounding the market. The CBOE Skew Index SKEW, +0.88% an options market barometer that gauges worries about highly unpredictable tail-risk, or “black swan” events, is up 0.9% to 127.09.
For the year-to-date, however, the SKEW is down 0.1% while the VIX is down nearly 19%.
That the SKEW, which tracks out-of-the money put options on the S&P 500 index SPX, -0.08% is diverging from the VIX is an indication that investors are still hedging against tail risks or black swans.
The last time the VIX and the SKEW diverged so significantly was between 2004 to 2007, ahead of the U.S. financial crisis, according to Michael Arone,chief investment strategist at State Street Global Advisors, in his midyear investment report.
“Markets subsequently corrected in 2008, marking the end of the U.S. housing market bubble and the start of the global financial crisis,” he wrote.
What is different this time, however, is that the Federal Reserve, which had been the white knight a decade ago, is on a tightening path.
Traders projected a 95.8% probability of an interest rate hike next week following the conclusion of the Fed’s two-day policy meeting on June 14.
And should the financial markets take a sudden detour, investors won’t be able to count on the government to provide much fiscal stimulus given the gridlock in the nation’s capital, he added. As such, Arone urged investors to brace for market sentiment becoming increasingly fragile and episodic spikes in volatility after June.