The stock market is set for more short-term upside after Wall Street’s fear gauge falls 5 days in a row, quant trading firm says

• The VIX has declined five days in a row to below 25, signaling more short-term upside for stocks.

• That’s according to Susquehanna International Group’s Chris Murphy, who highlighted positive historical returns following such a decline.

• The S&P 500 has returned an average of 3% over the next two-months with a hit ratio of 77%.

There could be more short-term upside ahead in the stock market based on the five-day decline in Wall Street’s fear gauge, according to Chris Murphy of Susquehanna International Group.

The VIX, which is a volatility index that helps measure investor fear on Wall Street, has fallen five days in a row to below the 25 level.

According to Murphy, that setup has led to strong short-term gains in the stock market, looking back over the past 30 years.

A five-day decline in the VIX below the 25 level has led to positive 2-week, 1-month, and 2-month average returns for the S&P 500 of 1.0%, 2.5%, and 3.0%, respectively, according to Murphy. In certain instances, the gains in the two-week, one-month, and two-month time frame after such a move in the VIX has led to S&P 500 gains as high as 5.3%, 10.3%, and 11.1%.

The VIX signal has also been pretty reliable for positive gains to show up in the stock market in the short-term, with a hit ratio as high as 77%. “[The] S&P 500 has historically performed well after a large 5-day pullback,” Murphy said.

The swift decline in volatility came after Federal Reserve chairman Jerome Powell raised the Fed Funds rate by 0.25%, representing the first interest rate hike since late 2018. Ongoing peace talks between Russia and Ukraine, fewer price spikes in certain commodities, and talks between the US and China also seemed to have helped dampen equity volatility over the past week.

A further 3% gain in the S&P 500 would launch the index to around 4,650 based on current levels. That type of move doesn’t seem to be out of question, according to technical analyst Katie Stockton of Fairlead Strategies.

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“The S&P 500 confirmed a breakout above its 50-day MA yesterday after having spent about two months below it. The cloud model presents another hurdle near 4520, but our indicators suggest it is surmountable. A decisive breakout above the cloud would increase the likelihood of a return to the highs near 4820,” Stockton said in a Tuesday note.

If the S&P 500 decisively stays above its 50-day and 200-day moving averages, which it finally reclaimed in Tuesday trades, Murphy’s historical analysis of the VIX decline and subsequent returns for the stock market should play out once again.

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