Is the August stock-market volatility behind us? This key indicator says not yet.

By Isabel Wang

The U.S. stock market is unusually quiet after a dramatic start to August, and that's making Wall Street panic - again.

Stocks have rebounded quickly after a bruising selloff that shook up global financial markets on Aug. 5. While calm appears to have returned to Wall Street after the recent mayhem, one volatility indicator suggests some investors are betting on another round of mammoth swings in the stock market.

Wall Street's closely watched "fear gauge," the Cboe Volatility Index VIX, has been in a freefall after peaking above 65 earlier this month. The VIX has fallen more than 75% since Aug. 5 to remain well below its long-term average of around 20 - its fastest retreat on record, according to Dow Jones Market Data.

Stock-market recovery has also picked up speed over the past two weeks. The Nasdaq Composite COMP on Monday exited correction territory after only 11 days. That was the shortest correction period for the tech-heavy index since October 2011, according to Dow Jones Market Data.

But investors are not just watching the VIX. Some are also keeping an eye on something called the VVIX, which measures the expected swings in the fear index itself. A surging VVIX suggests investors expect rising volatility in the VIX index in a 30-day period.

The VVIX index has risen over 20% so far this month, compared with a 0.6% decline for the VIX in the same period, according to FactSet data. On Thursday, the VVIX index was trading at 113.08, compared with its long-term average of 92.60, according to FactSet data (see chart below).

See: Powell's Jackson Hole speeches tend to lift the stock market - but when they don't, the drop is a doozy

How stocks usually perform after a significant surge in market volatility

Analysts at Bespoke Investment Group looked at the average return for stocks in every percentile of VIX and VVIX weekly average changes dating back to 1990 and 2006, respectively. As long as the VIX closes above 22.2 and the VVIX closes above 75, both will be in the top 1% of all readings.

The S&P 500 has averaged a 3.8% gain in four weeks after "an extreme surge" in VIX, and the large-cap benchmark index has also averaged an impressive 7.8% gain in a month following a big spike in the VVIX, the Bespoke analysts said.

The chart below shows the S&P 500's returns in one week and four weeks following the "extreme" surges in the VIX and the VVIX. It's worth noting the spikes in the VIX and VVIX in February and early March of 2020 led to a series of major losses in stocks before a huge rally, according to data compiled by Bespoke.

"There is a risk that the recent volatility spike is not sold down," the analysts said.

See: Stock market sees boom but bonds see economic disaster. Here's why they disagree.

The sudden rebound in U.S. stocks has caught investors who attempted to dump the risky assets off guard. However, volatility in the stock market is not "unidirectional," since the market's best and worst days have tended to happen together - often back to back during recession periods or bear markets, said Veronica Willis, global investment strategist at Wells Fargo Investment Institute.

This pattern also appeared in the most recent period of volatility, when the S&P 500 SPX logged its worst and best days since 2022 on Aug. 5 and Aug. 8, respectively, according to FactSet data.

See: The stock market is entering the most volatile period of the 2024 presidential election year

There are fears on Wall Street that the stock market will become more volatile in the weeks leading up to Election Day in November than at other times during the presidential cycle. The S&P 500's historical performance during election years suggests equities could experience a lackluster and volatile period between now and Nov. 5.

However, Aaron Clark, portfolio manager at GW&K Investment Management, said the brutal global selloff earlier this month was simply "technically driven," as he said "there hasn't been much change to the fundamentals" of the stock market.

In Clark's view, it was the elastic band that "might have been pulled a little bit too far with the megacap tech positioning" or "a one-sided trade where all the shares on the Titanic deck were shifted to the same side" as a small group of technology stocks continue to drive the rally this year.

"It was the weaker July employment data that shifted things, and it was a mad scramble for everyone to head to the exit door at the same time," Clark told MarketWatch in a phone interview on Wednesday. "But I don't necessarily subscribe to the view that it'll be more volatile because of the election and Jackson Hole, since a rate cut is fully priced in by markets."

U.S. stocks were lower on Thursday afternoon as investors awaited a speech from Federal Reserve Chair Jerome Powell at the Kansas City Fed's annual symposium in Jackson Hole, Wyo., on Friday morning. The Dow Jones Industrial Average DJIA was losing over 200 points, or 0.6%, while the S&P 500 was falling 0.8% and the Nasdaq Composite was tumbling 1.3%, according to FactSet data.

-Isabel Wang

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

08-22-24 1545ET

Copyright (c) 2024 Dow Jones & Company, Inc.