A measure of fear in stocks is breaking out to the downside, set to unleash a wave of buying power from hedge funds and other algorithmic traders to push stocks higher.
The Cboe Volatility Index, also known as the VIX, traded as low as 14.2 on Thursday, hitting its lowest level since February 2020, according to FactSet. The gauge traded around 15 on Friday.
Wall Street's fear gauge averaged nearly 30 in 2020 after an unprecedented sell-off in stocks drove the VIX to a record high of 82.69 in March. The crack below 15 is seen by some on Wall Street as a "risk on" signal as it could lead to additional institutional inflows into stocks. The market has been climbing to record levels since the VIX fell below 20 for the first time since the pandemic started three months ago.
The VIX, which tracks the 30-day implied volatility of the S&P 500, has dropped more than 12 points this month as the stock market hit record highs. The index looks at prices of options on the S&P 500 to track the level of fear on Wall Street. When it is falling, it means investors are getting less fearful and adding more risk.
"This week, the VIX is collapsing. And in a downside break," FundStrat co-founder and head of research Tom Lee said in a note Friday. "When the VIX normalizes (what is happening in 2021), the recovery in equities is unusually strong."
The strategist is one of the few on Wall Street who correctly called the market bottom in 2020 and its subsequent rebound.
The VIX tumbled 2.8 points, or 13.6%, on Monday as the stock market bounced back from last week's losses from the Federal Reserve's surprise hawkish pivot. The slide in the VIX took out support at the 50-day moving average of 18.35, according to Craig Johnson, chief market technician at Piper Sandler.
Lee said over the past 17 years whenever the VIX experienced a normalization in terms of term structure and level, the S&P 500 gained 23% over the next 12 months.
He sees the history repeat itself in 2021, forecasting an over 20% gain for the S&P 500. The broad equity benchmark has climbed 13.9% this year so far, trading at a record.
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