Flashing Red: Understanding the MOVE/VIX Index as a Timing Indicator
The MOVE/VIX ratio has surged again, reflecting one key reason to remain cautious about equities.
Cross-asset volatility is flashing red once again as the MOVE/VIX ratio, measuring US Treasury market volatility relative to US equity market volatility, has spiked. Currently, the ratio has surged above 8, nearing a level two standard deviations above average.
Elevated Treasury market volatility
For over a year, Treasury market volatility has consistently ‘outpaced’ equity market volatility. While many investors are aware of this trend, the crucial question must be: what to do with this divergence? We believe the heavy disparity in cross-asset volatility between equities and bonds provides another reason to underweight equities in a multi-asset portfolio.
The MOVE/VIX ratio chart below illustrates its trajectory since 1990. The current ratio (8.3) is at its highest level since 2005, although there was a period between 1993 and 1997 when the ratio was much higher, indicating the historical context of this volatility discrepancy.
Using the MOVE/VIX Index as a timing indicator
In this analysis, we will demonstrate that it greatly matters what drives an elevated MOVE/VIX ratio. The chart below reveals that the inflated level of the current MOVE/VIX ratio can primarily be attributed to the extreme volatility in the Treasury market. This differs sharply from the period of 1993-1997, where remarkably low VIX levels drove the MOVE/VIX ratio.
Our study focuses on the forecasting power of the MOVE/VIX ratio in relation to future equity and Treasury market returns. We conduct the following analysis:
We assess the 1-, 2-, and 3-month future relative returns of the S&P 500 Index against the Bloomberg US Treasury total return index when the MOVE/VIX ratio exceeds 7.0.
We also evaluate future relative returns when the VIX Index is trading above 20 in addition to the MOVE/VIX ratio being above 7.0. This provides additional return data when volatility is relatively high across markets. Mind you; the VIX Index is currently trading below 20.
To further distinguish between volatility regimes, we analyze return data from 1994 when the Bloomberg US Treasury Index began daily trading, encompassing most of the 1993-1997 period characterized by very low VIX Index levels. In addition, we also assess performance data excluding the low equity volatility environment, commencing in 2000.
The resulting analysis is presented in the table below, providing valuable insights into the relationship between the MOVE/VIX ratio and future market returns.
Key observations:
Panel A demonstrates that starting in 1994, on average, equities have exhibited modest positive relative returns over Treasuries when the MOVE/VIX ratio exceeds 7.0.
However, excluding the low equity volatility period of 1993-1997 starting in 2000, the S&P 500 Index has consistently underperformed the US Treasury Index after the MOVE/VIX ratio surpassed 7.0. This underperformance ranges from 1.4% to 2.4% over one to three months.
In Panel B – when the MOVE Index had to become extremely high to push the MOVE/VIX ratio above 7.0 given the VIX threshold of 20 – the outlook for equities gets outright unfavorable. On average, US equities have trailed US Treasuries by 1.9% in the first month following the breach of the 7.0 level by the MOVE/VIX Index. This underperformance intensifies over the three-month period, reaching nearly 6.0% (5.8% since 1994 and 5.6% since 2000).
Conclusion
According to historical cross-asset volatility data, the prospects for equity returns compared to Treasury returns appear lackluster at best. Since 2000, equities have underperformed Treasuries whenever the MOVE/VIX ratio surpassed 7.0. Presently, the ratio is at an impressive 8.3, indicating a potentially challenging situation. In the event that the VIX Index surges beyond 20, the outlook for equities will become particularly bleak, with the S&P 500 Index historically trailing by nearly 6% in the subsequent three months following a MOVE/VIX ratio of 7.0 or higher.