Is the decade-long volatility downtrend over?

With the recent rise in volatility, there is a clear case to answer over whether this is simply a short-term move or something that represents the end of a decade-long downtrend.

Trader
Source: Bloomberg

Volatility has been the talk of the town in recent weeks, with the crash in equity markets bringing about a sharp rise in the CBOE Volatility Index (VIX). One of the most consistent market trends over the past decade has been the decline of volatility, with the VIX peaking in 2008 and declining steadily since. However, with the VIX hitting a new two-year high this month, we have seen questions arise as to whether this represents an opportunity to short volatility once more, or else are we seeing the beginning of the end for that trend?

The VIX is a reference of the volatility seen in the S&P 500 market. However, while it tracks volatility, the relationship is typically one of an inverse correlation. With that in mind, any expectations of a reversal of the VIX downtrend would also denote a prediction of a bearish reversal for US stocks. This seems unlikely given the long-term uptrend for stocks, and with US economic data improving, there is reason to believe that we are moving into a phases of greater stability. While markets appear to be reacting to the prospect of rising interest rates, the anticipation of a year full of positive tax reform earnings announcements means that there is likely to be a significant amount of upside yet to come.

Looking at the long-term picture, the March contract shows a sharp break through trendline resistance earlier in the month, with the index closing in on the September 2015 peak. A break through there would be hugely significant, but until then, there is a chance we could be looking at the latest in a long line of short-term and fleeting spikes in volatility.

On the four-hour timeframe, we have seen a clear weakness in the recent fightback, with the price turning lower once more this morning. The 16.9 support level is going to be crucial, with a break to the downside expected to bring about a greater emphasis to the bearish case. With the recent spike looking short-term in nature, there is a strong chance we will see this market move back into the long-term downtrend. A break up above the 23.4 swing high would raise the likeliness of another resurgence in volatility. Until then, the bearish case is likely to be pursued once more for VIX traders.

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