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Fear index plummets to a 5½-year low

 Traders work on the floor of the New York Stock Exchange.

Story highlights

  • Wall Street's "fear index" has tumbled to a fresh 5½-year low as investors turn increasingly positive
  • Vix index tracks investor expectations of market volatility revealed in the pricing of options
  • Vix touched 13.2 points on Wednesday, the lowest since June 2007 at the start of the financial crisis

Wall Street's "fear index" has tumbled to a fresh 5½-year low as investors turn increasingly positive on the outlook for global stock markets.

The Vix index tracks investor expectations of market volatility revealed in the pricing of options that protect against violent moves on the S&P 500. As money managers typically seek protection against sharp share declines, the Vix is considered a gauge of how fearful investors are.

Despite the limp economic recovery and political gridlock in the US, and the simmering European debt crisis, the Vix has continually been ground lower over the past year, and touched 13.2 points on Wednesday, the lowest since June 2007.

Fund managers and strategists said the low Vix reflects the fact that central banks are seen as backstopping financial markets, lessening demand for downside protection. Signs of a tentative rotation by investors out of bonds and back into equities has further bolstered optimism.

"It is a reflection of this global recovery broadening out, starting to stabilise," said Jim Paulsen, chief investment strategist at Wells Capital Management. "Market players are starting to become de-sensitized to Armageddon, end-of-the-world stories."

The Vix is not the only measure of implied volatility that currently indicates a pacific outlook. Europe's Vstoxx stock market turbulence gauge and the CVix index, which reflects the expected choppiness of global currencies, are both near the lowest since mid-2007.

The low demand for protection reflects the fact that global stock markets have been in robust shape recently. The MSCI World Index gained more than 13 per cent last year, its best performance since the recovery from the global financial crisis in 2009.

"Lower tail risks have helped propel markets higher over the past half year," said William Davies, head of global equities at Threadneedle, a UK asset manager. "The eurozone doesn't look like it will implode, China's economic growth seems to have bottomed out and the fiscal cliff was avoided, for the time being."

Nonetheless, many strategists warn that the Vix is unreasonably subdued, given the still-cloudy outlook for the US debt ceiling negotiations and the prospect of continued stresses in Europe.

"We are going through period where the market knows there are some large macro obstacles on the horizon," said JJ Kinahan, chief derivatives strategist at TD Ameritrade. "So the index might remain low for the next couple of weeks, but that might change as the next debt ceiling debate begins."

Indeed, futures contracts on the Vix indicate that investors expect the gauge to climb above 20 points within half a year, and the volume of bets remains elevated.

"Volatility is volatile," points out Pam Finelli, a senior strategist at Deutsche Bank. "If we see some extremely bad news, we could see the Vix double in a few days."