Wall Street's favorite fear gauge soared more than 13 percent Monday, reflecting trader sentiment that the stock market is likely to move lower.
The Chicago Board Options Exchange Volatility Index (Chicago: VIX) again climbed past the 30 level amid a gloomy outlook for the global economy that presaged a sharp negative move from stocks. A reading of 30 or better is generally indicative of high volatility and seen as a bearish sign for the broad-based Standard & Poor's 500 index.
Options traders have been betting on a higher VIX recently. More signs have begun to indicate the VIX was likely to keep gaining as investors look for the long-awaited pullback from the massive three-month rally that has sent stocks about 35 percent higher from the March lows.
"Fear is definitely back in the market," said Dave Rovelli, managing director of US equity trading for Canaccord Adams. "It's a huge move. People don't know what to do."
Stocks fell Monday after the world bank issued a downbeat outlook for most of the world's economies.
Commodities stocks, looked to be a leadership group if Wall Street was heading into a true bull market, weakened significantly. At the same time, Dow transports, often considered a bellwether for market movement, fell about 4 percent, more than double the Dow 30's loss and another troubling sign for the market.
"People are seeing all that all these green shoots are starting to turn a little brown," Rovelli said, using an oft-quoted metaphor from Treasury Secretary Ben Bernanke to describe signs of an economic turnaround.
With second-quarter earnings looming and the unemployment rate continuing to push toward 10 percent, Rovelli said investors are turning understandably fearful.
"You can't go into earnings when we have the unemployment rate rising," said Rovelli, who is advocating careful stock picking of dividend-paying bluechips amid the expected rough times ahead. "If unemployment goes up there's really no upside in the market."
As for the VIX, traders continued to place bets the index would go higher.
One options player last week made an $850,000 bet that the VIX was heading past 45 by mid-July. The VIX peaked just below 90 last November.
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At the same time, the spread between the VIX, VIX futures and actual volatility began to grow, yet another typically bearish sign for the market.
The VIX spot number and the VIX futures spread grew to above a 3.20 premium, a bearish sign for the S&P, Larry McMillan, president of McMillan Analysis, said in a research note.
Actualy volatility has been 22 percent for the past 20 days while VIX July futures were at 31.35, with August at 31.55 and September at 31.70. All three figures were eclipsed during Monday trading.
"This will either be resolved via an increase in actual price volatility (most likely on a move to the 880 level in SPX); or alternatively, the trading range will maintain its integrity and the VIX and VIX futures will converge toward actual volatility levels," McMillan wrote.
To be sure, some investors use the VIX as a contrarian indicator, believing that a move higher will cause panic and make stocks cheap enough to buy.
But Rovelli said those making that kind of bet could regret it.
"We had the huge move. If you weren't along for the move you missed it and now you've got to pick stocks," he said. "The party's over."
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