Cassandra's Red Flag

Last Weekend the Financial Times carried an article about the VIX index and the dangers that lie ahead. However Futures Magazine wrote an article back in April also alerting savvy investors of the headwinds coming our way. Below is the article in full.

VIX Red Flag

Equity markets spiked higher and the CBOE Volatility Index (VIX) gapped lower on Monday April 24, buoyed by the results of the French presidential election last Sunday. Centrist and pro-European Union candidate Emmanuel Macron came in first and is polling well ahead (20+ points) of far-right rival Marine Le Pen. The two will face off in a May 7 run-off.

Positive earnings continued to provide strength for equities throughout the week, but rallies across global stock markets show the French election was the major driver. The VIX gapped three points lower, closing on Friday April 21 at 14.63 and opening on Monday at 11.56. That is a significant move of more than 20%.

It is also an unusual gap, but not unprecedented. The last time the VIX gapped lower like that was in July 2015. A month later the S&P 500 entered into a significant correction and did not recover to make a new high until almost a year later in July 2016 (see chart below)

There are a few other similarities that make this chart intriguing. In July 2015 the S&P 500 hit its all-time high weekly close during the week the VIX gaped lower. However, the high basically set a double top, being less than a point higher than the previous weekly high close set a month earlier.

The cash S&P 500 set an all-time weekly high the week ending April 28, which was only be marginally higher than the weekly high set in February. If history repeats itself, we could be lining up for another historic May sell-off and setting a long-term top. Also the gap lower this week (more than 20%) is significantly more than the gap from July 2015 (10%). It is not clear whether that strengthens the case for a spike in volatility in the near future, but it makes sense for traders to have their guard up.