What Really Caused the Market Whiplash: VIX Spike & Interest Rates

What in the world just happened in the stock market?

Investors have been getting market whiplash for the past couple weeks, as the market has taken wild swings in both directions.

Uncertainty about interest rates and inflation have been the primary causes of the volatility, but we’ve also witnessed one of the fastest and biggest movements in the CBOE Volatility Index (VIX) since it began tracking in 1990.

Plainly put, the VIX measures the level of activity in options on the S&P 500. And options are bought when people believe that the S&P will make a big move sometime in the future.

After months of being at record lows, the VIX spiked 177% in two trading days, and then went back down 48% just seven trading days after that.

So what does that mean?

Since the financial crisis, that 225% price swing has been the second biggest in a period of three weeks or less. The only bigger one was back in August 2015, when the VIX experienced a 249% swing in just two weeks.

So what that means is the level of anticipation for a big move in the market was recently just as big as it was in August 2015.

A month after that spike ended, the market was down another 3%. That’s been the case with most VIX spikes: an initial rally in the market afterward, followed by another leg down.

Just as a reference, the 2015 VIX spike was due to the crash of the Chinese markets. And a crash in the markets of the second-biggest economy in the world is well deserving of a ripple effect that extends into the U.S., as we import $400 billion to $500 billion worth of goods from China every year.

That’s a little different than worrying about interest rates going up in the future after they have been going up for years.

I think the recent spike in the VIX was the result of people worrying about the rapid pace of the market’s rise over the past 12 to 18 months. That led to investors hedging their bets a little once the fear of higher rates set in.

Then a couple initial down days in the market triggered a ripple effect that saw an emotional sell-off because nobody had been used to the market going down.

So, I think the market will continue to rally out of the hole that was caused by a big overreaction.

I know that goes against the results of past VIX spikes, but they should be taken on a case-by-case basis.

Right now, the U.S. economy is at its best point since the financial crisis. That means interest rates should continue to rise at the moderate pace they’ve been going up since December 2016. In this economy, another dip in the market would be a good opportunity to buy, not a reason to sell.

Regards,