Climbing a Wall of Worry: Is This Obscure Indicator Saying We’re At the Top?

June 30, 2023

There’s an old saying in the financial world that the stock market tends to “climb a wall of worry.” 

It refers to when a bull trend keeps rising in the face of bad news. A negative economic report shakes up the market… An unexpected twist in geopolitical relations… A natural disaster impacts an area of the country… And the market still manages to rally…

That’s climbing “a wall of worry.”

Lately, an (in)famous measurement of that wall has been popping up in the news. 

It’s called the VIX. 

And you should understand what it is…

The VIX: A (Very) Brief History

VIX is short for “volatility Index.” It was created back in 1993 for the Chicago Board Options Exchange (CBOE) by Professor Robert Whaley — sometimes called “the father of the fear index.” 

Whaley, director of the Financial Markets Research Center at Vanderbilt University, designed the index to predict (“guess-timate” is probably a better word) the potential volatility that market participants were expecting over the ensuing 30 days. 

It was originally based on the S&P 100 (OEX) but in 2003 was recalculated by Goldman Sachs to track the S&P 500. 

The index is calculated based on the implied volatility of a range of option prices on the S&P 500. This is a little bit geeky but option prices are calculated by mathematical models which, among other things, estimate the likelihood of an underlying instrument’s price reaching a particular level (a “strike price” in options parlance) within a certain amount of time. The greater the expectation that an underlying price would reach more extreme prices, the higher the volatility priced into the option. Higher volatility means higher option premiums across the board.

Bullish trends, even at the extremes, generally tend to be more orderly (and profitable for investors) so volatility tends to move lower during these phases. Bear trends, on the other hand, come from profit taking — a “get out of Dodge” mentality — which generates more market activity and pushes volatility higher. 

So as the market goes higher, the VIX will generally go lower. Until prices reach an extreme and the market corrects. 

That makes the VIX what you might call a contrarian sentiment indicator.  

This is what it looks like lined up over its index… 

24 Years of SP 500/VIX (Monthly)


You can see a couple things right off the bat. First, the inverse relationship between the VIX (black bars) and the S&P 500 (purple bars). Because it’s a monthly chart, I formatted the VIX as bars rather than a line so you can get an idea of the extremes the index can reach. At its most extreme, during crises like the market collapse in 2008 and more recently in 2020, the VIX can reach readings of 85 to 90. 

But like I said, those are extreme measures. More “modest” panics have seen the index spike to the 40 to 50 range. During the nice, calm bull trends, an average of 15 is reasonable. 

As a bull trend becomes more and more established —  that is, as investors become more and more complacent and stop worrying about something upsetting the rise — the more likely the market is closing in on some sort of top.

That’s the basic idea. But how useful is it?

Not Exactly Forward Looking

The thing is, the VIX is helpful, but it doesn’t really “predict” anything. Like any sentiment indicator, it suggests overbought and oversold conditions in the market by interpreting the volatility priced into option premiums. 

But there is no official cut-off. 

There’s no terminal point at which everyone hits the panic button.

Like any other sentiment indicator it can signal overbought or oversold conditions for a long, long time.

Take a look at the chart below. It shows the S&P 500 along with the VIX back in 2018. You can see the market had been rallying pretty aggressively since August of 2017 rising 19% in a matter of months. And during that period the VIX was happy to trade in a very “complacent” range of 9 to 11. 

S&P 500/VIX in 2018


The market put in its top on January 26. It gapped lower on January 30 and then again on February 2. By the end of that session, the market had dropped 4% of its value in a matter of five trading days. 

Along the same timeline, you can see that the VIX had broken out of its range, but had barely eclipsed the 17 level. It showed the beginning of some concern on the part of traders. But by no means suggested what was still in store for the market. 

Over the next five trading days, the market collapsed another 8% (giving up 12% over all and erasing all the gains for 2018 to that point) and the VIX exploded to over 37.

So what does this example tell us? 

The edge you get by tracking the VIX comes from professional option traders — the option market makers that the VIX is based on — who are very sensitive to changes in volatility. So while the index is more reactionary than predictive, it can be useful at the extremes when changes start to happen in a hurry.

But again, there are no absolutes where VIX levels go.

What’s the VIX Saying Lately?

After a particularly rough 2022, the stock market has been enjoying a fairly sustained bull run since October of last year. 

Here’s a look at a daily chart from the last eight months…

S&P 500 / VIX


The low in the market last October corresponds with the high in the VIX. The two have been trending in opposite directions ever since.

Recently, however, pundits have noted that the VIX has hit low levels not seen since February 2020. So… does that make the rally vulnerable?

First remember that while low volatility expectations does suggest complacency may be building in the market (what you might expect at or near a top) it’s just a sentiment indicator. There are no hard and fast levels that say “buy” or “sell.” The index could easily settle into this range for weeks or months. 

A second factor you want to notice, is that this rally has been marching along in the face of some pretty significant economic and geopolitical uncertainties.

The Fed has been on a rate hiking binge… attempting to tame what’s turning out to be some seriously sticky inflation… which has continued to raise the specter of a recession in the not too distant future… all while we’re funding a war in Europe… spending which is pushing our national debt to new highs nearly every day… and all while tensions are increasing between us and our chief geopolitical rival — China.

Yet despite all that… The market doesn’t seem to have a care in the world.

I’ve mentioned before that much of the current rally has been driven by the TBTF Tech crowd on the promise of the coming AI revolution. That’s made them pretty much impervious to the higher rate environment we’re seeing. 

That said, any kind of news that might be deemed bad for AI, like the Biden administration’s possible sales restriction of semiconductor chips to China, could negatively impact the market.

But absent that, as the Wall Street Journal noted, an extraordinary calm has stretched over the market…

It has now been more than three months since the S&P 500 has pulled back at least 3%, one of the longest such stretches since World War II, Deutsche Bank research shows. The average weekly move for the benchmark has been less than 1% in either direction since the end of March, according to FactSet. In late 2022, the index averaged swings of roughly 2.6% each week.

And despite the coming Q2 earnings season offering some possible fuel for a volatility fire, July isn’t a month for fireworks beyond what you see on the 4th…

The S&P 500 has moved an average of 0.53% a day in July over the past decade, the quietest month of the year according to Dow Jones Market Data.

Have a great Independence Day!

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential