Goldman Sachs: The Case For A Higher VIX

While low VIX levels may not, at least historically, suggest an impending market decline; Goldman Sachs are sympathetic to the argument that the VIX seems low. That begs the question, what has tended to get the VIX off the couch and moving again?

Historical perspective: VIX < 11 on 1.8% of trading days since 1990

The VIX closed at 10.6 last Friday, its third consecutive close below 11. Sub-11 VIX levels are actually pretty rare. We estimate that only 1.8% of VIX observations back to 1990 have dropped below 11 with less than 1% falling below last Friday’s closing level of 10.6.

  • For historical perspective, we look at the percentage of time the VIX has close at various levels in the past in Exhibit 1.
  • While most investors think of typical VIX levels being around 20, the distribution of closing VIX levels shows that a large chunk of VIX levels actually occur when the VIX is in the low teens.
  • If we look at fairly granular one unit increments, we estimate that the VIX has closed between 10 and 11 about 1.7% of the time back to 1990.
  • The largest bucket in our histogram is the 12-13 range where the VIX has spent 8.6% of its time.

The case for higher volatility

  • The economy will eventually need to confirm the recent optimism in asset prices: While the “soft” survey data has been on the stronger side, the “hard” economic data will need to improve in order to justify the recent advance in risky assets as highlighted by Charles Himmelberg. That may be a tall order at a stage of the business cycle where growth headwinds could stem from limited spare capacity.
  • Policy uncertainty is high: As argued by our economists, while the political and policy outlook for 2017 has started to take shape in the past few weeks, many details remain unclear at this early stage of the Trump administration.

In fact, VIX is over 40 points underpriced relative to policy uncertainty...

The case for low levels of volatility

  • Policy is a process not an event: Legislation takes time. If Brexit and the US election taught us anything it may be that unexpected political outcomes may not in and of themselves lead to higher volatility. It takes time for actual legislation to be written, passed and implemented. Options require a path (puts vs. calls) and a timeframe (they expire). With no clear cut policy initiatives yet on paper and no idea of a potential timeframe, the market seems to be willing, over the short run, to give the new administration some time.

Exhibit 3 shows that most VIX spikes have either been unpredictable major geopolitical events or adverse economic or financial shocks.