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October is often fraught with volatility. We’ve seen some of that this year with the CBOE (Chicago Board Options Exchange) Volatility Index (VIX), known as the fear index, jumping above 30 in recent weeks. For background, the VIX uses options pricing to arrive at an expected price change in the S&P 500 looking ahead 30 days. The figure is then annualized.

A hands-on way traders use the VIX is with the so-called “rule of 16.” This rule says that each multiple of 16 is an extra 1% in expected daily movements in the S&P 500. So, a VIX of, say, 32 implies a 2% daily change, up or down in stocks. The VIX math works out to an implied 9.2% swing over a month’s time.

A VIX history lesson

Stepping back in time, it was 35 years ago when the infamous crash of 1987 took place. The Dow plunged 22.6% as the S&P 500 suffered its largest one-day percentage decline on record of 20.5%. Compare those single-session bear markets to this year’s 16.0% fall on the Dow and 22.0% drop on the S&P. It goes to show that bear markets come in many flavors – some are short with heightened panic while others are drawn out and the pain comes through time.

But the VIX didn’t exist in 1987. There was a product, though, that the CBOE constructed a year earlier. The CBOE S&P 100 Volatility Index (VXO) was similar to the S&P 500’s VIX Index. For historical comparison purposes, it allows us to see what volatility was like during the crash on Oct. 19, 1987. According to the CBOE, VXO spiked above 150 by the close of trading on “Black Monday.”

Chart titled: Black Monday: 35 Years Ago: Volatility Catapulted Above 150 in 1987, A Record High. Chart dates from January 1987 to December 1987 shows CBOE (Chicago Board Options Exchange) S&P 100 Volatility Index (VXO) at 20 in January 1987 and staying in that range until it spikes above 150 in October 1987 and begins to drop in late October 1987. Source: Ally Invest, CBOE.

Volatility is in check vs history

Jump ahead to other bear markets, like the ones in 2007-09 and early 2020, and you’ll find that volatility surged above 80. The rule of 16 suggested a typical daily move of 5% back then. That makes 2022’s average VIX figure of 26 seem tame. It doesn’t feel that way though, right?

This year’s stock market drop has been a relatively slow bleed compared to corrections seen from 2010 through 2021. After the Great Financial Crisis (GFC) and through the COVID-19 bear market, it was common for the S&P 500 to drop and then snap back in short order, forming what traders would deem a “V-bottom.” The term described the nature of the sharp decline and just-as-swift recovery to new highs – that has not happened in 2022. Buying the dip has been punished, not rewarded, this go-around. Case-in-point, we saw a nearly 20% rally back in the summer only to reach new lows in October.

Using the VIX to spot the end of a bear market

But can the VIX provide clues on when a market bottom happens? Maybe so. Of course, there’s no sure thing in the investment world, many technical analysts suggest a spike in the VIX might be needed for a true shakeout, thus laying the foundation for a longer-term recovery and possible bull market.

While today’s VIX around 30 is high compared to its long-term average of 19.6, it’s not a sign of a bear market low in equities. Since 1997, it is routine for volatility to surge to the 45 to 53 range during crisis highs. We saw that in the summer of 1998, during the 2000-02 bear market, and during four different corrections from 2010 through early 2018.

Chart titled CBOE (Chicago Board Options Exchange) Volatility Index 1998-2022. VIX Spikes To Near 50 Historically Seen. Chart dates from January 1998 to present day, shows VIX Intraday Spikes at 30 in January 1998 and stays between 50 and 10 until January 2010 where it shoots up to 90, then again stays between 50 and 10 until it spikes to near 90 in March 2020 before dropping to 15. Source: Ally Invest, CBOE.

Why it’s different this time

Of course, the panics in late 2008 and during the COVID-19 crash resulted in sharp VIX moves north of 80. We don’t expect that to happen this time with most company balance sheets in good order and a resilient consumer. The fundamental picture is simply much better compared to the risks faced during those two severe bear markets. Investors need to recognize that recessions are not uniform – some are shallow while others (such as the GFC) are incredibly painful and that may leave scars on the investor’s psyche.

Investors should also remember that though recession fears are prevalent, the S&P 500 often bottoms and moves higher before the end of a technical recession in the economy. Moreover, right before a midterm election, is historically an ideal time to stay invested.

The bottom line

A hallmark of a bear market low is a spike in the VIX. While it doesn’t happen every time, a final burst of fear and capitulation after months of market declines is common. It’s something to watch out for, but not panic in the face of, in the coming months.