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The 'fear index' is falling, and that's a good sign for stock pickers

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In another sign that stock picking may be back this year, the so-called fear index has fallen to its lowest level in more than two years.

The CBOE Volatility Index (.VIX) hit 10.30 on Friday, a fresh low going back to July 3, 2014, and near levels not seen since before the financial crisis. That low volatility comes from stocks moving less as a huge group and more on their own individual merits — and that's good for investors who think they can pick winners.

"You're starting to see a lot more differentiating between the stock market, and that's driven the correlations down, and that's kept volatility low," said Peter Tchir, head of macro strategy at Brean Capital. "That means it's finally the stock picker's market."

VIX 15-year performance

Source: FactSet

Over the last several years, stocks of all sorts of companies have tended to move higher or lower as one huge group. The phenomenon is known among serious investors as "correlation."

Now, because investors are factoring in their hopes for a growing economy, higher interest rates and the impact of policies under the Trump administration, broader market volatility has declined and correlations have fallen to multiyear lows. The closer a correlation is to "one," the more likely that moves in one sector match shifts in another sector or sectors — meaning that it matters less which sector investors pick to put their money in since they all do the same thing.

Since the election, some sectors have jumped more than 10 percent, while others have fallen slightly. The gainers have more than offset the decliners, and the S&P 500 has repeatedly hit all-time highs without falling more than 1 percent on a single trading day since October.

"The market is just taking its cue from the fact there's a severe lack of realized volatility. ... Market participants have been conditioned that any weakness in the market is short-lived," said Daniel Deming, managing director at KKM Financial.

This week the VIX has drifted lower, falling near 11, or below, to its lowest since 10.28 the day before Independence Day in 2014. Before that, the lowest read on the VIX goes back to Feb. 22, 2007, when the index hit 10.01.

"With the VIX below 11, it still feels like within the market there's a lot of churning going on" as different sectors rise or fall related to policy expectations and earnings, said Brian Nick, chief investment strategist at TIAA Investments, an affiliate of Nuveen. "I don't think it's complacency."

The VIX is considered the best gauge of fear in the market. It measures the buying of put and call options on the S&P 500 near-term options. Puts and calls give their buyers the right to sell or acquire an asset in the future, respectively, at a price that's set in advance.

To be sure, Ilya Feygin, managing director and senior strategist at WallachBeth Capital, said the low volatility and low correlations were due more to traders waiting for clarity on government policy.

"I think once the market sells off on some type of disappointment, correlations will rise again," he said.