The market's 'fear gauge' is hitting rock bottom. Should you be scared?

It’s getting awfully quiet out there in the stock market. A little too quiet.

The CBOE Volatility Index (VIX), also known as Wall Street's "fear gauge", has been scraping along historically low levels around 12. The long-term average for the VIX is 19.6, according to Dow Jones. The VIX, which is derived from trading activity in S&P 500 options expiring within the next month, represents the expected range of movement for the S&P 500 over the coming year.

When volatility sinks to such depths and remains subdued, it is often a signal to market participants that a selloff is on the way.

So are financial advisors worried about a potential Jaws (hey, it is summer) lurking below the market’s still waters, ready to pounce on their client portfolios? And if so, are they cutting bait on this bull market, up 12 percent year-to-date?

Christopher Davis, partner at Hudson Value Partners, says the VIX currently shows a lot of complacency in the market. That said, absent a geopolitical shock beyond the level that markets seem to be numb to, he believes it might be a “quieter summer.”

“With earnings season just concluded, we see more green and yellow lights than outright red ones,” said Davis. 

Meanwhile, Brian Glenn, chief investment officer of Premier Path Wealth Partners, believes a low VIX is much less predictive than a high VIX. As a result, he reacts less to it low readings.

“Historically, a high VIX has been a wonderful time to lean into risk-on assets, particularly equities. It provides a much better tactical signal if that’s your investing or trading style,” said Glenn. “A low VIX, however, is generally the norm.”

“Since its 1990 inception, the VIX has averaged around 20,” said Glenn. “It’s been below 15 about 30% of the time and above 25 roughly 15% of the time. So it’s much more ‘timely’ to use the high VIX – often consistent with fear in the market – as a buy signal than a low VIX as a sell signal.”

Cyrus Amini, chief investment officer at Helium Advisors, says the VIX has fallen to such a low level in part due to continued economic resilience in the US, which has been reflected in the equity market’s rise so far this year. As a result, he does not believe the drop in implied volatility suggests a significant market correction is imminent.

“Recent geopolitical events plus the Fed’s decision to maintain higher interest rates haven’t dented the market’s enthusiasm. There will certainly be more fluctuations in the VIX this year, but we would expect them to center on second half US elections and potential earnings weakness,” said Amini.

Along similar lines, Tom Graff, chief investment officer at Facet, attributes the low VIX to a strong economy, but also the proliferation of ETFs and hedge funds that short volatility as their primary strategy.

“With a lot of volatility sellers and not that many buyers, it makes sense that the VIX would get very low,” said Graff, adding that he does not believe this portends any kind of correction ahead.

Finally, Nick Codola, senior portfolio manager at Orion, agrees that having a VIX of under 13 does not point to a high likelihood of a severe market correction coming in the next 6 to 12 months. Nevertheless, it does mean that it is more likely than not the market will see higher VIX readings in the future, according to Codola. And if and when the VIX does rise, don’t expect it to shoot too high to the upside.

“While there is a good chance, around 54 percent chance based on 64 readings, that the forward six month average VIX price will be greater than 13 once we get a greater than 13 VIX print, there has only been one time where the next six months had a flip to reading of over 27 and that was COVID,” said Codola.