Keep Your Eyes on the VIX

MarketsMotley Fool

There are a number of things that would have caught a savvy investor's eye on Thursday. The Dow was off nearly 1%. The S&P 500 was down almost 1.5%. And the Nasdaq lost more than 2.1%.

But while these are the headline numbers that investors tend to watch, there's one metric that moved much more than any of these. And it also happens to be the single most telling gauge of the stock market right now -- at least in my opinion.

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I'm talking about the S&P Volatility Index (VOLATILITYINDICES: ^VIX), more commonly known as the VIX. This is an index that measures anticipated volatility in stocks over the next 30 days. It does so by looking at activity in the market for puts and calls -- derivatives that allow someone to bet on the direction of a particular stock or index over a given set of time in the future.

The lower the VIX, the lower the expected volatility, and vice versa.

The average closing price of the VIX is 19.5. That's going all the way back to 1990. By contrast, over the almost 7,000 trading days since then, it has closed below 10.0 on only 28 days.

And here's the kicker: the majority of those days, 19 of them, have come this year.

That's right. Despite everything going in the world right now, according to the VIX, volatility is expected to be historically low. Eerily low, in my opinion.

The VIX has gotten a lot of press of late. And lots of people have offered their opinions about why it's been so low. Yet, none of the analyses I've come across offer a convincing explanation. But just this week, things began to change. In July, the VIX increased or decreased by an average of 3% each day.

So far this month, the average is up to 8.3%. And on Thursday, it climbed 44%, closing at 16.04. You read that right. On Thursday, the VIX shot up by 44%. The last time it closed this high was Nov. 8, 2016 -- the day of the presidential election.

Now, again, it's impossible to say what's going on here with any semblance of precision. For example, surely the escalating war of words between the leaders of the United States and North Korea plays into it.

But underlying all of this, too, is the fact that stocks are trading at the third-highest valuation in history, aside from 1929 and 1999.

My point is that the market is in unusual waters.

Maybe nothing will happen, and stocks go sideways. Maybe Congress gets its act together and passes tax reform, which would fatten corporate coffers, sending stocks higher. Maybe an international conflict leads to a dramatic decline in stocks.

It's impossible to say. But investors should steel themselves for any of these potential outcomes.

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John Maxfield has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.