Wall Street 'Fear Gauge' Flashing Rare Signal

The S&P 500 Index (SPX) has surged nearly 4.8% so far in January -- and there's still more than a week of trading left -- on pace for its best month since March 2016, and its 10th straight monthly gain. However, even as U.S. stocks assail record heights, the CBOE Volatility Index (VIX) -- or Wall Street's "fear gauge" -- is also on pace for a big month, currently up 4.3% in 2018. This rare occurrence has happened just 12 other times in history. Below, we take a look at how the stock market tends to perform when both stock prices and volatility expectations are on the rise.

Most Signals Flashed During the Dot-Com Bubble

Specifically, the last time the SPX rose 3.5% or more in a month at the same time the VIX was positive for the month was in February 2017. Prior to that, you'd have to go all the way back to December 2003 for a signal, per data from Schaeffer's Senior Quantitative Analyst Rocky White. The majority of the signals flashed just before the dot-com bubble burst, with six occurring between June 1997 and March 2000.

Stocks Could Underperform in the Short Term

Following previous signals, the S&P tended to underperform in the short term, giving up 0.19%, on average, in the subsequent month, and higher just 41.7% of the time. That's compared to an average anytime one-month gain of 0.73%, with a win rate of 64.2%, looking at data since 1991.

However, three and six months after signals, the S&P 500 was higher 75% of the time, with average returns roughly in-line with anytime returns. One year after signals, the index outperformed, with an average gain of 10.23%, and a win rate of 81.8%. That's compared to an average anytime one-year return of 8.85%, with 78% positive.

In conclusion, when the S&P and "fear barometer" tend to soar in tandem, it's been yet another signal of short-term weakness and long-term strength for the stock market. Considering the historic run-up of stocks in 2018, not to mention signs of extreme optimism, those concerned that overbought stocks are due for a breather may want to heed founder and CEO Bernie Schaeffer, who recently noted that options hedges against a correction are priced to move.