Are equity investors getting worried? Are they turning bearish after weeks of optimism?
Yes, they are, indicates the latest movement in the Volatility Index also known as the “fear index,” which measures investor sentiment and their expectations of stock market volatility.
The Chicago Board Options Exchange’s Volatility Index , better known as the VIX, has risen over 20 percent from a low hit on August 17. It jumped 13 percent last week alone, suggesting fear is creeping back among investors.
Analysts say a rise in the VIX, which is a good indicator of risk appetite, points to a likely correction in equity markets.
“Historically, when you get the VIX at these levels there is usually a pull-back of around 10-15 percent (in stock markets),” Steven Brice, Chief Investment Strategist at Standard Chartered Wealth Management Group told CNBC Asia’s “Squawk Box” on Tuesday.
“(But) We think it (the pullback) will be lesser this time because Europe and China are likely to respond and this will limit the downside,” he added, referring to expected monetary and fiscal stimulus measures from the euro zone and China.
Expectations that European policymakers will take decisive action to deal with the euro zone debt crisis, while the U.S. and Chinese central banks will ease monetary policyfurther to boost economic growth have lifted sentiment in equity, currency and commodity markets in recent weeks.
The S&P 500 index and the MSCI Asia-Pacific Index excluding Japan have both rallied more than 10 percent since early June, while shares in Europe have jumped around 15 percent.
A dose of caution, however, has entered markets as expectations were dampened by comments from St Louis Fed President James Bullard, who said last week current economic conditions in the U.S. were not bad enough for more easing.
Plus investors are awaiting a number of key events that are likely to set the tone for trading over the next few weeks. The U.S. Federal Reserve Chairman Ben Bernanke is due to make a speech at the Jackson Hole annual symposium on Friday, while the European Central Bank holds a policy meeting next week.
“We would say a 5 to 10 percent (stock market) correction is more likely,” said Standard Chartered’s Brice. “The risk is that we don’t get (Federal Reserve Chairman) Bernanke signalling something coming through and the ECB disappoints with the timing of any measures.”
Mitul Kotecha, Head of Global Currency Strategy at Credit Agricole, says that the rise in stock market volatility will also rub off on the currency markets.
“The rise in equity volatility suggests that the relative calm experienced over the summer may be ending. Markets are getting a bit more nervous…. This suggests there will be a bit more of a difficult and volatile period for currency markets,” Kotecha told CNBC’s “Capital Connection” on Tuesday.
Kotecha added that the increased uncertainty means the euro, which ran up to a seven-week high against the dollar last week, could now find itself struggling to push higher. He said the single currency was likely to be capped at $1.25.
- By CNBC's Dhara Ranasinghe