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Father of Wall Street’s ‘fear gauge’ sees wild volatility continuing until coronavirus cases peak

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The Cboe Volatility Index (VIX), has become one of the most widely watched indicators of market sentiment in the world. 

In theory, it works on a simple principle: It is a measure of the stock market’s expectation of volatility over the following 30 days based on near-term S&P 500 index options, both puts and calls.  The higher the number, the greater the expectation that market volatility will be higher over the next 30 days. 

This week, despite a massive rally that saw the S&P rise nearly 20% from its Monday low to its Thursday high, the VIX remained stubbornly high, in the 60s, all week. These are levels that have been rarely since its inception in 1993.

Robert Whaley is often referred to as “the father of the fear index.” He is the director of the Financial Markets Research Center at Vanderbilt University.  He spoke to me by phone from his home in Nashville.

 What is the VIX telling us now?

“The VIX measures expectations of volatility 30 days out.  Right now, with the VIX near 70, the index is saying that the intraday swings on the S&P 500 will be 4% to 5% on a daily basis, which is an awful lot of volatility.”

What would it take to bring it down, let’s say to the 30s?

“We need to reduce the uncertainty level.  The S&P has been swinging in daily prices swings of 4%, 5%, 6% or more for several weeks.  The VIX is just an estimate of future volatility, so traders look at the actual volatility that is through the roof and they are naturally assuming some of this volatility will continue.”

 If the intraday swings went down to something lower, say 2% or 3%, would that calm down the VIX?

“Possibly, but the most important thing is to resolve the uncertainty, which may be determining a peak in coronavirus cases.  If you get any good news on that front, the VIX will drop very quickly.”

VIX futures are in backwardation — the near term prices, particularly the cash price, are far higher than contracts farther out.  What is this telling us?

“It tells me the volatility will be lower several months out.  For example, the April contract expects the VIX to be below 55, in May it is 45, and in June it is below 40.  A week ago, the price of that insurance on the June contract was 50.  It’s dropped 10 points.  It’s come down very quickly. The VIX is saying it will be in the 30s by August.”

Robert Whaley, Vanderbilt professor, “father of the VIX”

Source: Vanderbilt University

 So this is not going to continue indefinitely?

“No, it gets like this when you get crisis, like 1987 or 2008.  You said last week that people are not going to pay this high a price for insurance indefinitely, and you are right.  The VIX contracts are predicting the prices will drop.”

 Is it accurate to call the VIX a “fear index?”

“Yes, that’s all it is. The S&P 500 option market is driven by the purchase of put options, which institutions are using as portfolio insurance.”

 But the VIX is also moved by call options as well?

“Yes, but my research indicates that it is primarily driven by put options.  The volume of put option open interest is greater than call option open interest, and the formula that the VIX is derived from weights puts more than calls.”

 What was your role in the creation of the VIX?

“I created the original VIX in 1992.  The CBOE hired me to create a volatility index.  They wanted a product to differentiate them from an ordinary index like the S&P 500, and they wanted to create a new asset category that might be a long-term investment.” 

 It certainly seems like they succeeded.

“They sure did.”

 

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Market closes above a key milestone, setting up stocks for more gains

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The Wall Street Bull (The Charging Bull) is seen during Covid-19 pandemic in New York, on May 26, 2020.

Tayfun Coskun | Anadolu Agency via Getty Images

The stock market closed above a key milestone and looks set to keep moving higher for now.

The S&P 500 broke above its 200-day moving average for a second day, but this time succeeded in closing above it. The S&P 500 surged 44 points to 3,036 on Wednesday, after trading weaker early in the day. Before this week, the S&P was last above the 200-day on March 5.

The 200-day happened to be at 3,000, a level that is also seen as psychologically important.

The market was helped Wednesday by a steadying in momentum names, like Netflix and Tesla that touched their lows of the day just before 11 a.m. ET.  The S&P 500 hit its low at about the same time, as the group which includes the FAANG names, Facebook, Apple, Amazon, Netflix and Google parent Alphabet, all started to turn higher.  

Those big tech names that have been drivers of the market took a rest this week, as traders focused on names that will benefit from a reopening economy, like airlines, banks and industrials. The S&P financial sector is up more than 9.6% this week so far, and industrials are up more than 7.%. Communications services, which includes internet names, was up just 0.8%.

“Another feather in the hat of the market for reclaiming the 200-day. We’ll see where it takes us,” said Scott Redler, partner with T3Live.com. “Tech had one more washout recovery to relieve some pressure and got back in line. I wouldn’t be surprised if tech acts better and the reopening trade takes a rest, like banks and the airlines.”

The 200-day is simply the average of the closing prices for the last 200 days for an index or even individual stock. In the case of the S&P 500, some investors view the 200-day as a line in the sand, where they will go long above  that level but not below it. That can generate interest in the market and help pull it higher.

Redler said the S&P 500 could face new resistance when the index reaches 3,080, a zone where the market broke down in March.

Paul Christopher, head of global market strategy at Wells Fargo Investment Institute, said the broadening out of the rally has been important and should help propel stocks. “The market has to figure out there’s more than one story to price,” he said, noting it would be hard to have a sustained rally without FAANG.

“In order to have a sustained rally, you needed broader participation. We still worry their fundamentals are not consistent with … gains we are seeing, especially in a lot of those smaller regional banks,” he said. Christopher said it’s unclear what kind of loan losses they could face in real estate, and from businesses like restaurants. 

“The rotation we’re seeing is a rotation to value, to small caps. It’s as if everything that got beaten up was getting a bid,” he said.

Christopher said there are headwinds for the market, including the rising tensions between the U.S. and China. That could come into focus later in the year, as the presidential election gets closer and candidates discuss China relations. For now, however, the V-shaped recovery is being seen as possible by some investors who see progress in the reopenings, he said.

“I don’t think this has registered yet,” Christopher said. “The market is still paying all of its attention to the accumulation of recent hopeful signs, not to cold hard facts, about a vaccine, a successful opening and a V-shaped recovery, which had been dismissed before.”

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Asia Pacific stocks set to jump as U.S.-China tensions ramp up

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U.S. Secretary of State Mike Pompeo told Congress on Wednesday that Hong Kong was no longer autonomous from China, raising questions over the special administrative region’s favorable trade relationship with the U.S.

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Huawei CFO loses major battle in extradition fight

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Meng Wanzhou, chief financial officer of Huawei Technologies Co., leaves the Supreme Court in Vancouver, British Columbia, Canada, on Tuesday, Oct. 1, 2019.

Trevor Hagan | Bloomberg | Getty Images

Huawei’s chief financial officer Meng Wanzhou lost a major legal battle in her fight against extradition to the U.S. to stand trial on fraud charges.

In the Wednesday ruling, the Supreme Court of British Columbia found that the case against Meng meets a standard called “double criminality,” where the acts the U.S has accused her of are also illegal in Canada. The next phase of proceedings will begin next month. 

Diplomatic tensions are rising as Meng, who is the daughter of Huawei founder Ren Zhengfei, will have to remain in Vancouver on bail during a lengthy extradition process. 

Shortly after the court’s decision, the Chinese Foreign Ministry urged Canada to release Meng immediately and ensure her return to China. The Global Times, which is aligned with the Communist Party of China, blamed the U.S. for the ruling, saying Canada’s judicial and diplomatic independence has fallen to “U.S. bullying.” 

Huawei, the world’s largest telecommunication supplier, has been a flashpoint for the Trump administration’s trade battles with China. Shortly after Meng was arrested in December 2018, President Trump weighed in on the extradition case, telling Reuters he might consider “intervening” in the case if it would help the U.S.- China trade war. On Wednesday afternoon, legislation calling for sanctions against China passed both houses of Congress; President Trump has not said whether he intends to sign it into law.

The U.S. Commerce Department has also targeted Huawei. It blocked shipments of semiconductors to the company from chip-makers. That followed the administration’s move to keep Huawei on the U.S. Entity List, a blacklist that restricts American firms doing business with the company. The ban is hitting Huawei’s bottom line. The company reported it saw slowing revenue growth in 2019

Huawei said it was “disappointed” in the ruling and maintained Meng’s innocence.

Meng is due back in court June 15.

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