By Mark Hulbert

The past several months have illustrated why the VIX — the CBOE Volatility Index — is not a reliable contrarian stock-market indicator.

Last December the VIX VIX fell to 12.07, for example, its lowest level since 2019, lower than 90% of the index’s daily values since its creation in 1990. That should have been bad news for the market, according to contrarians who interpret a low VIX reading as indicating too much bullish complacency. Nevertheless, the stock market is 13.3% higher now (as measured by the Wilshire 5000 Total Return Index).

The VIX is only slightly higher than last December. Its closing price on March 28 was at the 18 percentile of the historical distribution — lower than 82% of all daily readings since 1990.

It’s not just Monday morning quarterbacking to point out that the stock market tends to do well when the VIX is low. Last September, for example, I reported on research that found the stock market performs better when the VIX is low than when it’s high . That’s the mirror opposite of what contrarians believe.

The research was conducted by finance professors Alan Moreira of the University of Rochester and Tyler Muir of UCLA. They devised a market-timing model that takes advantage of the stock market’s tendency to do better, with less risk, when the VIX is low than when it’s high.

Those interested in a more detailed description of the professors’ model should consult their study, which appeared in the Journal of Finance . But in a nutshell, their model calls for increasing equity exposure as the VIX declines, and vice versa. A simplified way of putting their model into practice requires just two steps:

• Pick a target equity allocation that corresponds to a middle-of-the-road VIX level

• To calculate your equity exposure level in any given month, multiply your target by the ratio of your VIX baseline to the closing VIX level of the immediately preceding month.

To illustrate, let’s assume your target equity exposure level is 60%, and you choose the VIX’s median historical level (17.69) as your baseline. Based on the VIX level of 13.01 at the end of March, your exposure level for the month of April would be 81.6% (which is 60% times the ratio of 17.69 to 13.01).

Why the model works

The professors’ model beats the market because it produces better returns relative to the volatility it incurs. That’s an important point because the contrarians aren’t wrong to believe that the stock market often performs well when the VIX is high. What they don’t fully appreciate is that the market is also extremely volatile when the VIX is high. As a result the return-to-volatility ratio is lower when the VIX is high.

This is illustrated in the table above, which is based on all VIX readings in the U.S. market since 1990. Focus in particular on the first and last rows, which reflect the 25% of days in which the VIX was the lowest and the 25% of days in which it was the highest, respectively. Notice that while the stock market’s average subsequent return was smaller for the lowest quartile, it was produced with less than half the volatility. In terms of the return-to-volatility ratio, the lowest quartile comes out ahead.

Bear in mind that the bullish potential of a low VIX reading applies to the short term only. If the VIX were to jump, the professors’ model would quickly call for taking money off the table. The point of their model, however, is that we should not jump the gun. The VIX can remain low for some time, as we’ve seen recently; it therefore pays to give the market the benefit of the doubt until the VIX climbs markedly. It will sooner or later.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at

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