Just the Vix

In my oft-repeated "Wall of Worry" chart, I've been using the Vix Index divided by the 10-yr Treasury yield as a proxy for the market's level of worry. With 10-yr yields now down to record-setting lows (0.75% as of this writing), putting the 10-yr in the denominator slot makes it the dominant variable. Yields have been pushed to unbelievably low levels because the world is not just pessimistic about the prospects for growth, the world is desperate for a safe-haven hedge against the great unknown which is the Corona virus. The entire Treasury universe has become the most desirable hedge for investors worldwide.

So I'm switching back to just using the Vix index (i.e., the implied volatility of stock index options, which is essentially a measure of how expensive options are). In the past 20 years, stock options have only been more expensive than they are today once, and that was near the end of the 2008 global financial panic.

Chart #1

Chart #1 compares the level of the S&P 500 to the level of the Vix index. The Vix index is a measure of the implied volatility of stock index options. That's a good proxy for the market's level of fear; it's also a measure of how much investors are willing to pay for the safety of options. Owning an option on stocks  is less risky that owning the stocks outright, because the worst that can happen to an option you own is that the option's price can fall to zero—and you lose only what you paid for the option, which in turn is only a fraction of the value of purchasing the underlying stocks.  

It should be clear from this chart that as the Vix index soars, stock prices approach sharply depressed levels. Stock prices then advance as fear subsides (i.e., the market climbs a wall of worry). Peaks in fear coincide with lows in stock prices.

Chart #2

Chart #2 looks at the Vix index going back 20 years. Each vertical bar represents the high, low, and closing value of the Vix index during each month. A value of 50 marks the biggest stock selloffs. The biggest one of them all happened at the end of 2008, when investors feared that global financial markets and global economies were on the verge of collapse. Things aren't likely to get that bad again, we hope, just because of a nasty little virus.

I'm tempted to say that today's Vix value of 50 is probably the high-water mark for the Corona scare. But that temptation is checked by my guess that I'm not the only one to make this observation. There's lots of money available to buy today's "dip." The bottom will occur when "buying the dip" becomes almost intolerably scary.

Chart #3

As Chart #3 shows, credit risk fears (using credit default swap spreads as a proxy for corporate credit risk) have indeed jumped, but they are still short of true panic levels.

Chart #4

As Chart #4 shows, 2-yr swap spreads have also jumped, but not by very much. Systemic financial risk is still relatively low and there is still plenty of liquidity in the system. Central banks are working hard to accommodate the market's desire for safety and liquidity. The global economy may be at great risk of a recession, but, unlike 2008, global financial markets are still relatively healthy.

Back near the end of 2008 it was hard to imagine how the world would avoid collapse and "the end of the world as we know it." Today it's not very hard to imagine how the world can avoid a global pandemic: all it takes is the development of a vaccine and/or therapeutic drugs. And work to that end is already well underway.

UPDATE: after hours, March 6th: Dramatic change just prior to the close today, with the Vix index plunging and stock prices soaring. Just prior to the reversal, the Vix index had surged to 54 (only to subsequently decline to 42), and that was enough to encourage bottom-fishing and buy-the-dippers. Maybe we have seen peak panic.

Chart #5

Chart #6

Note that Chart #6 reflects the intra-day high of the Vix, whereas Chart #5 shows the closing level of the Vix.