The main U.S. small cap index, the Russell 2000, is hitting all-time highs, yet the CBOE Volatility Index (VIX) is also elevated. It’s not supposed to happen this way, which means we are likely looking at a sign of significant market froth.
This chart depicts the long-term inverse relationship between the Russell 2000 and the VIX. When the VIX rises in year over year terms, this is a sign of increased market fear and lower investor risk tolerances. Small cap stocks, more volatile than their large-cap counterparts, have historically performed poorly during periods of rising investor anxiety. In short – VIX up, small caps down.