Keep things simple when this is spiking, as you’ll see here in the past in 2020 during the COVID crisis, 2008 during the great financial crisis, and then most recently during the the tariff conversations, trade talks this year. When this spikes up, the market is not necessarily happy.
This is when things are selling off. Bit of a panic in the in markets. This is when people get nervous and start to sell. Conversely, when things are below average and an average level in the VIX being around a 20, as you’ll see here in the long [00:01:00] term below 20 is the waters are calm, people are confident about the future, not a lot of uncertainty out there.
So that’s when bull markets are happening. Bear markets you’ll see is when we’re above this level of 20, for example, this whole chunk here is 2022. It feels like forever ago, but a few short years ago had a pretty poor performance in the market. A lot of that contributed to the high levels of the VIX throughout a significant portion of the year.
So what we saw. Was really a stable market to start the year all through 2024. And then as soon as the tariff trade talk started happening, we saw a increase very quickly. Can even zoom in here in the last three years to give some perspective. So we saw levels spike well above 50 in the VIX, so important levels to watch here is 20, the long-term average.
So if we’re below that, things are pretty calm. If we get above that in between 20 and [00:02:00] about 27, we’re still in a normal market, in quotes. Things aren’t too panicky, a little elevated, but nothing, some sort of geopolitical crisis going on. Once you get above 28, 27, 28, then it starts to get to, okay, something, something is happening that has investors nervous.
The next important level to watch will be 35. So that would be another seven points above that 27, 28 level. When you hit here, some things are really making people nervous, and we saw that spike through during the peak of the tariff conversations recently. And if we go back, a 10 year number here you’ll see 2020, obviously huge spike in the VIX when we were shutting the economy down due to COVID.
And then in 2022 we never really broke through that crisis level of 35. We were above the, one standard deviation that level of 27 and hovered around there. ‘Cause we never really had a [00:03:00] particular event in the back half of 2022. We saw the initial spike with the invasion of Ukraine. However, that didn’t rattle markets too much relative to, trade talks now, the 2020 spike as well as if we go back even further to the great financial crisis. And in 2008, the the significant spike there as well.
So going back to the short term and what gave us a little bit of confidence after this happened, we saw this huge spike. This is again, the worst part of when tariffs were going on with China, reciprocal tariffs. We had a thought in the back of our mind that, hey, we saw something similar in 2018.
In 2018. I’m gonna shift this chart around to then. Because that is when president Trump at the time, during his first term, was getting into trade conversations and trade another trade war with China specifically, less [00:04:00] so broad across the entire globe. We saw that initial spike happen. We hit, crisis ish levels of the VIX again, in February of 2018, that’s when the steel tariffs were happening. And then as soon as any sort of news came out or resolutions happened with the tariffs, we saw the volatility drop very quickly. We saw it again in later, in 2018 with more, trade talks lingering, festering again.
But another thing significant in spikes in the market, in spikes in the VIX, sorry. The spike later in the year had to do with the Federal Reserve potentially making a pivot annual increasing interest rates too fast too soon. So we saw the market get less sensitive to trade conversations.
So, when we go to this year for the VIX, we saw that huge spike when the tariffs came out and everybody, every country out there was getting hit with some level of tariffs and the numbers were extraordinarily high. And we saw [00:05:00] this unwind very quickly as things were punted, the 90 day delay, tariff numbers were reduced.
And now, most recently a trade, a pseudo trade deal with China coming out. A lot of the volatility went down rather quickly. So in the back of our mind, our minds were, Hey, this will be ugly, as long as the leading headlines are trade tariffs. But as soon as that rolls off the market historically has responded rather well.
So we were a little bit, we were a little bit cautiously optimistic during this. As soon as the news changed, we think that we thought the market would change too. And then jumping over to another thing that gave us some confidence during all of this was the high yield credit spreads. High yield credit spreads are simply the measure of the risk-free treasury rates you can get versus the rates you’re getting for the riskiest bonds out there.
So junk bonds is what they’re, commonly referred to as. So the difference between those two yields. Is [00:06:00] this spread right here when this is elevated, I see going back to 2008 when we hit the peak levels there. This is when the bond market is extraordinarily nervous about junk bonds. So when the credit market is nervous about junk bonds, that means they’re worried these companies are gonna be defaulting.
‘Cause if you look at a bond investor, the peak return of bond investor can get is the yield of the of the bond, there’s not the equity upside you can get. It’s really is their peak return is gonna be whatever the yield is, the coupon is the day they are purchasing it. So when these levels are very high, people are very nervous.
No one’s buying the high yield spreads. They’re gonna be buying the treasuries instead, ’cause they are worried that these companies are gonna default and they’re gonna get no return. So this is a very sensitive part of the market ’cause there’s no equity upside there. So when we’re looking at these levels, when levels are low, the opposite’s true bond [00:07:00] investors, again, the most sensitive risk averse investors are feeling confident.
When that cohort is feeling really strongly about what’s gonna happen going forward, then as equity investors or allocators between stocks and bonds, we can look at it like, okay, if the risky, the risk averse guys are not nervous, then we can be a little bit confident as well. So important levels to look at here.
Long-term average, going back before 1995 is about five and a quarter is the long-term average. When we’re above these levels, that’s when recession fears are really high. Because if you’re getting a lot of company defaults, you’re getting layoffs. That’s when wage inflation’s gonna drop like crazy.
And that’s when you know consumer demand falls. All those cascading events can happen when companies are defaulting on their debt and declaring bankruptcy. So that’s when the spike around recessionary fears. We saw a big spike in 2020 that flipped around pretty fast as the federal reserve and fiscal spending came to [00:08:00] the rescue.
We saw a big spike, obviously leading into 2007, 2008, 2009, and that continued on for a while. Even through the the worst of the equity market periods and then the unwind there as well. And then we saw a increase, not a huge dramatic spike in 2022. However, it did increase up to the, the long-term average.
So this is when interest rates were rising faster than they ever have before. Investors were nervous that, a recession was for sure going to happen. However, that did not come to fruition. Now if we look here towards the bottom, we did get a spike, and I’ll go in the last, I’ll zoom in a bit here.
The last 10 years we did get a spike here when the tariff conversation happened. Now we were coming off of almost all time lows in the spread. So going from peak confidence to almost back up to average levels in the in the high yield spread, we had to get up to five and a quarter for the long term average.
So we did get a spike there. [00:09:00] However, what gave us some confidence was if the most nervous part of the market did not get these spreads up to at least five and a quarter where, we’re looking at real recession conversations. Then we had a little bit of confidence as well seeing okay, things are ugly right now.
As soon as the rhetoric changes around tariffs and focus more back onto earnings and things like that, things seem to look like they’re stabilizing. And then if the credit investors, again, the most risk averse investors out there were not that concerned about the underlying companies defaulting and going bankrupt, then we could feel a little bit confident as well that we didn’t have to make any dramatic changes, across the board for all the clients here at Pennsylvania Capital.
So yeah, just wanted to go over those few things. Talk about what we’re seeing right now. We’ve seen a big flip around in both the VIX and the spreads in the last couple weeks. Returning back to, below average levels, so again, something we’re always keeping an eye on to make sure we’re looking through the noise here and not reading the headlines and [00:10:00] overreacting to any one particular, news item.
Making sure we’re looking through that through the market price action, and can make decisions confidently for the clients. Thanks everyone.