How Long Will This Bull Run Last?

Market Insights

Bulls are back, the market has never been this resilient to J-Powell’s comments since the covid crash.

But will this strong bullish momentum be sustainable?

That will be our main focus today — let’s look at how the VIX Index relates to annual S&P 500 returns and what it can tell us about our current market conditions.

Let’s dive in:

I am taking your attention to VIX because the VIX has gone from an average close of 20.7 (above the index’s long run average of 19.4) in Q1 to 16.6 (well below the long run average) in Q2.

This suggests there is something “different” about the US stock market now versus just a few months ago.

Simply put, there is much less fear about a swift drop in stock prices now than there was at the start of 2023.

This is the chart that shows the VIX from 2003 to 2022:

I also include the data showing VIX’s annual average in each year (bottom line of numbers, green means below avg, red means above avg) and the S&P 500’s total return in each year (top line of numbers).

THREE important points about this chart and the data in it:

#1 — Markets are rarely trading around long run average volatility levels (19-20). In other words, markets are usually either in a low-volatility or a high-volatility environment.

While the average VIX reading over this timeframe is 19.4, any given year often shows average levels that are quite far from the 20-year mean value.

Also, periods of low-vol can run for several years in a row (2004 - 2007, 2012 - 2019). High-vol periods can cluster as well (2008 - 2011), but they tend to be much shorter (2020).

#2 — Low volatility markets seldom see annual losses, and their average total returns are much better than high volatility years.

Since 2003, only one low-vol year saw a negative return: 2018, due to the Fed’s policy misstep related to an overly aggressive estimate of the neutral interest rate. Volatility shot up in Q4 2018, crashing stock prices, but once the Fed backed down in early 2019, the VIX went down to 15.9, which leaded to a 31.2% annual gain on S&P.

The average annual return for low-vol years is 14.5%, but for high-vol years the return is just 4.9% on average.

Yes, there are years when S&P ended the year with good returns on high-vol, but they also have insanely bad runs as well, which averages them out and make investor’s job much harder when VIX number is high.

#3 — My thoughts about this critical relationship:

Market psychology ebbs and flows based on investor’s views of Macro Risks. When those are low (typically during economic expansions), the VIX runs below average and stocks perform well.

Volatility shocks (2008, 2011 and 2020) tend to see VIX decline in the near future years and stocks big rebounds. Our last year (2022)’s worries about structural inflation and Fed policy definitely counts as such shock.

It is difficult and will have to take a LOT negative catalysts to “surprise” the market with new information that is able to “wake up” the VIX to switch from below average to above average:

• 2008 (Global Financial Crisis)

• 2011 (European Debt Crisis)

• 2020 (Global Pandemic Crisis)

• 2022 (Global Inflation Crisis)

And the good news is — all these periods were followed by some of the best buying opportunities in the history to profit from the market.

Here are the TWO important takeaways I would like to share with you on our current market conditions:

Takeaway #1 — The VIX’s move lower over the last 3 months is telling a very specific bullish story about US stock market, particularly the large caps.

Specifically, the VIX is saying that we are shifting from a high-vol to a low-vol regime. History shows the latter is much more common and also delivers much better returns.

Takeaway #2 — The current new VIX regime sets the bar quite high for the market in terms of what sort of catalyst is needed to derail the current rally.

Handwringing about recession fear is not enough, and nor are worries about whether the FOMC will move once or twice more in 2023.

These issues are already well understood and widely priced in. Even the prospect of military mutiny in a global nuclear superpower like Russia has not been enough to take the VIX even close to long run average.

It is a quite a bullish sign for the remaining of the year, and the bull run should continue for the remaining of the year with minor pullbacks. I wouldn’t be surprised if S&P 500 makes a new ATH by Dec.

Chart of the Week

The US 2-Year Treasury Yield is still the most important short term indicator when it comes to calling the near term direction of US stock market:

The relationship between the direction of 2Y Yields and stock market is clear:

• When 2Y trends UP, stocks DOWN

• When 2Y trends FLAT or DOWN, stocks UP

This shows the current stock market is extremely sensitive to the monetary policy expectations and changes, which reflexed on the short term treasury yields.

One important main takeaway from this chart:

Recently from early May, S&P 500 has rallied 5.6%, however, the 2Y Yield also rallied from 3.75% to 4.9%, which seems goes against the usual relationship we mentioned above.

The tells us that stock market has a high degree of confidence in the combination of economic & earnings growth and the predictability of future Fed monetary policy.

We want to see the 2Y Yield stays BELOW the previous high, which is 5.05%, in order to keep up the confidence level and maintain the current bullish momentum.

Therefore, keep your eyes on the 2Y Yields over the next couple of weeks, especially the Q2 earnings season is coming.

That’s it for today.

See you next week!

Vic