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Wall St's fear gauge suggests the worst is over
June 29, 2009 / 11:15 PM / in 8 years

Wall St's fear gauge suggests the worst is over

By Rodrigo Campos - Analysis

<p>A street sign on Wall Street outside the New York Stock Exchange in New York April 18, 2007. REUTERS/Eric Thayer</p>

NEW YORK (Reuters) - Growing confidence that the U.S. economy is putting the worst recession in decades behind it has pushed the index known as Wall Street’s fear gauge to its lowest level since just before Lehman Brothers collapsed last September.

The CBOE Volatility Index .VIX, known as the VIX, provides investors with portfolio insurance against fluctuations in the S&P 500 index .SPX. It soared to historic highs in the weeks after Lehman's rapid failure pushed financial markets to the brink and left an already crippled economy in tatters.

But amid numerous signs the economy is on the edge of a recovery, coupled with the best quarter for stocks in more than 10 years, the VIX has begun to look like its old self again.

“Investors see a lesser need for protection going forward; it looks like they don’t see a revisit to the March lows,” said Andrew Wilkinson, senior market analyst at Interactive Brokers Group in Greenwich, Connecticut.

The VIX, which is calculated from Standard & Poor’s index options, tracks the market’s expectations of volatility over the next 30 days. It often moves inversely to the S&P benchmark and goes up as options premiums are raised.

The S&P 500 .SPX hit a more than 12-year low in early March, down more than 57 percent from the record high it set in October 2007, after the bursting of the housing bubble spiraled into a credit crisis and then into a global recession.

The VIX hit an intraday record high of 89.53 in late October, but on Monday it closed at 25.35, its lowest level since September 11, 2008, before the weekend when Lehman collapsed.

“The path forward appears a less treacherous one according to what the VIX is telling us,” Wilkinson added.

Stabilization of key economic indicators such as payrolls, home prices, bond yields and consumer confidence, as well as the Obama administration’s plan to reactivate the recession-hit economy, have boosted bets on the economy’s outlook. Investors are looking forward to this week’s key housing and job market data on expectations that it will show further signs that the worst is over.

“I think (the VIX) is down primarily because the expectation is the economy is going to recover and we’ve started a bull market,” said Hugh Johnson, chief investment officer of Johnson Illington Advisors in Albany, New York.

The S&P 500 has risen up to 40 percent from its March lows, and is on path to close its best quarter since the fourth quarter of 1998. But even as some market players expect a correction in the near term, the reading of the VIX suggests that that correction may not happen.

“The bears are beginning to throw in the towel on expecting a substantial stock market decline, so investors are beginning to sell implied volatility,” Wilkinson said. “Investors do not perceive there’s going to be another big crash.”

But although the VIX has returned to levels similar to those seen before financial markets imploded, analysts said that does not mean the economy has recovered from the hit it took last year.

“We’ve gone through such a change in the economy that has required such drastic steps from both the Federal Reserve and the government that it is going to create a very different landscape going forward,” added Wilkinson. “We can’t relate (today‘s) VIX measures to were we’ve come from.”

Additional reporting by Chuck Mikolajczak; Editing by Leslie Adler

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