Key stock sentiment index back to pre-meltdown levels

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One of Wall Street’s favorite measures of investor sentiment has reached its most sanguine level since just before Lehman Bros.’ collapse -- the event that fueled the global financial-system crash.

It’s a milestone, of sorts, in the markets’ attempt to move on from the debacle of the last eight months.

The VIX, or volatility index, gauges investors’ expectations of near-term volatility in the stock market. It’s calculated based on activity in Standard & Poor’s 500 stock index put and call option contracts. Investors and traders use options either to bet on market swings or to hedge against them.

When the VIX falls sharply it signals that many investors and traders believe the stock market has a relatively placid outlook. When it rockets it says the opposite -- that Wall Street fears that things are going to get much worse for the market.

Just before Lehman Bros. filed for bankruptcy protection on Sept. 15, the VIX stood at 25.66. In the nine weeks that followed, as credit markets seized up worldwide, the VIX soared to unprecedented levels -- signaling a level of investor panic most Wall Street pros had never experienced.

By Nov. 20 the index reached 80.82. It was the equivalent of a market heart attack and stroke rolled into one.

Since then the VIX has been coming down, albeit in fits and starts. Even though major stock indexes reached their bear-market lows in the winter sell-off that ended March 9, the VIX never again got close to November’s highs. It has fallen further in the spring rally, and dropped below 30 on Tuesday.

‘The VIX is telling us that the perceived risk in the market is so much lower now,’ said Jon Najarian, a veteran trader and founder of brokerage Trademonster in Chicago.

To put it another way, investors may not be sure that stocks will keep going up, but they don’t see the return of the kind of insanely wild swings that marked last fall’s collapse.

Still, Najarian notes, at 28 the VIX is historically high. Indeed, until a year ago, any spike above 30 signaled a significant level of fear. And those spikes typically marked a good time to buy stocks, because whenever the VIX has reached extremes it has been a great contrarian indicator: Investors (or at least traders) would have been wise to go against the crowd at those points.

But as with so much else post-Lehman, investors have to allow that whatever was considered normal in the past has been replaced by a new normal. In this case, Najarian said, the VIX may already be low enough to suggest that investors are getting too comfortable with stocks, raising the likelihood of at least a short-term pullback that would put a little more fear back into the market.

So far in this 10-week-old rally, however, every modest sell-off has quickly attracted buyers from the sidelines. Just as the market upended the bulls for week after week last fall, it’s confounding the bears this spring with its persistent push north.

-- Tom Petruno