Fear has disappeared in Wall Street’s slow-motion bear market

(Bloomberg) — For all the pain that has piled up in the U.S. stock market, one thing has been surprisingly in short supply: fear.

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Virtually every corner of Wall Street is wracked with concern that rising interest rates will push the economy into recession, causing huge price swings in everything from junk bonds to foreign currencies. But the CBOE volatility index, the so-called fear gauge of stock investor sentiment, remains well below levels seen in previous bear markets.

Options strategists and bankers cite a simple reason: The S&P 500 has been experiencing a long and orderly decline from the record level reached earlier in the year as the Federal Reserve withdraws its avalanche of pandemic-era stimulus. That differs from shock-driven crashes like those caused by Covid-19 in March 2020 or the collapse of Lehman Brothers Holdings Inc. in September 2008, both of which sent the VIX higher as investors looked to hedge. the risk of sudden changes in the market.

“Negative sentiment dominates the conversation as bull market excesses are stripped away,” Lewis Grant, senior portfolio manager at Federated Hermes, wrote in a note. “However, the VIX index is only marginally elevated. For stocks at least, this is an orderly bear market rather than an outright panic.”

In fact, this year the VIX has not broken above the key level of 40, which many pundits see as a maximum sign of fear. It jumped to twice that level early in the pandemic and during the 2008 credit crisis.

Today’s market is more like the one that followed the dot-com crash, another period in which stock valuations fell from what many considered unsustainable highs. The VIX currently implies a 2% daily move in the S&P 500, according to Talal Dehbi, senior sales and quant strategist at PrismFP.

“Current behavior is similar to the dotcom bear market of 2000-2002, with no big sudden shocks but sustained high volatility,” he said.

As a result, traders are not turning to volatility hedges en masse. Take the bias, which measures the relative cost of hedging against a one standard deviation drop in the S&P 500. Its cost hovers around June 2019 levels.

The sidelined volatility concerns may also reflect another element of the stock market decline. As deep as it has been, with the S&P 500 down 18% this year, the causes are well known: tighter monetary policy and rising inflation. The main question is when those two give way enough to allow the market to turn.

The S&P 500 rose more than 3% on Friday, the biggest gain since May 2020, after a reading on inflation expectations eased and a Fed official suggested recession fears are overblown.

“Not enough investors have panicked and bought short-term protection options, which would push the VIX index much higher,” said Edmund Shing, chief investment officer at BNP Paribas Wealth Management.

There are few signs that that will change. The VVIX Index, which measures implied volatility in Volatility Index Options, is below 100 and recently hit its lowest level since January 2020. That means traders are expecting smoother sailing for the VIX Index.

That makes the actions relatively unique. An indicator of expected volatility in the Treasury market, the ICE BofA MOVE Index, is hovering around the highs reached at the peak of the March 2020 selloff. The same is true of the JPMorgan Global Currency Volatility Index.

“Inflation, Federal Reserve policy and interest rates are fundamental to market risks. Therefore, the MOVE is exceptionally high,” said Dean Curnutt of Macro Risk Advisors, citing the divergence in volatility in bonds and equities.

BNP’s Shing said he is surprised the VIX has not risen along with measures of corporate risk, such as the cost of credit default swaps that protect against a default, which have risen sharply this year.

In recent bear markets, the VIX has typically risen to 45 before the S&P 500 bottoms out. That’s about where it peaked in 2002, which marked the end of the dotcom bust. On Friday it ended around 27, below the day.

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