The volatility index of US stocks is at a critical turning point. Will the S&P 500 index's decline continue?

Zhitong Finance and Economics APP learned that currently, a sign of stock market volatility is at a level that typically signals the S&P 500 index is approaching a short-term bottom. Due to the global stock market decline and rising volatility, investors are buying options to protect themselves from further selling pressure. The unexpectedly weak US July non-farm payroll data released last Friday, with the unemployment rate rising to 4.3% triggering the "Sam Rule," has exacerbated concerns in the market about the Federal Reserve taking too long to cut interest rates. The level of this concern is so deep that the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) futures have inverted, indicating that current uncertainty is higher than future uncertainty.

It is reported that the trading level of the August VIX futures contract is 24.4, higher than the 23.8 of the September VIX futures contract. The last four instances where the near-month VIX futures contract traded higher than the second month occurred in June and October 2022, October 2023, and April 2024, with the S&P 500 index approaching a short-term bottom during these periods.

Last Friday, the VIX index rose to 29.66 at one point, closing at 23.39, 5 points higher than Thursday's close. Citigroup strategist Vishal Vivek and others pointed out that relative to its historical and linear relationship with the S&P 500 index, the volatility index should only increase by 2 points, with the 3-point "excess" growth in the 99th percentile of historical observations since 1990.

Steve Sosnick, Chief Strategist at Interactive Brokers LLC, said, "The sharp rise in volatility last Friday symbolizes the end of the short-term negative trend in the stock market. It doesn't necessarily tell you about the long-term cycle."

Traders are rushing to buy options on the S&P 500 and VIX. In addition, the VVIX index, a measure of volatility volatility, surged to its highest level since March 2022, marking the largest weekly gain since 2017. This is another sign that in a market that has been relatively calm, there is suddenly a demand for hedging against significant volatility. VVIX is now at the high end of its historical range over the past five years, while VIX remains within its normal range.

Tanvir Sandhu, Chief Global Derivatives Strategist at Bloomberg Intelligence, said, "If the volatility of the volatility index remains high, it may indicate expectations of a more turbulent period."

The expanding selling pressure has suppressed the market sentiment towards small-cap stocks. The one-month put skew of the SPDR S&P 500 ETF Trust Fund is the highest since June 2023, while the one-month put skew of the Invesco QQQ Trust Series 1 tracking the Nasdaq 100 index is the largest since October last year. Even the put option premium of the iShares Russell 2000 ETF, which is different from other well-known ETFs, has rebounded from its mid-week low.

As market volatility - whether up or down - expands, realized volatility has also sharply increased, more than doubling since early July to its highest level since November last year. This may limit the investment capacity of some funds aimed at limiting volatility. At the same time, stock correlations have risen from a historical low at the end of June, when investors were chasing the rebound of artificial intelligence and tech giants.

Tanvir Sandhu said, "The realized volatility of the stock market has risen from a low level, which is a problem for system strategies that use it as an input for automatically adjusting risk exposure size. If realized volatility continues to remain high, this will limit the leverage these funds use in the rebound."