The 'fear index' is sending some surprisingly strong signals for the TSX

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On Wednesday, while major U.S. stock markets were closing at record highs and the S&P/TSX composite index was within striking distance of closing at its own all-time high, the VIX Index slumped to an 18-month low.

The VIX Index, or Chicago Board Options Exchange (CBOE) Volatility Index, is a measure of the 30-day implied volatility of S&P 500 index options. This index is commonly called the "fear gauge."

Generally speaking, it can be a good measure of investor sentiment.

The higher the index level, the more market nervousness there is. The lower the index level, the more complacency in the market.

Right now, the VIX is below 11, a level we have not seen since July 2014, reflecting the current bullish market sentiment.

So is this market exuberance indicative of a market top, or does the bull market have room to rally further? Will buyers keep buying, pushing major equity indexes even higher?

To answer these questions, I looked back over the past decade to see if there was a relationship between the VIX and the market returns. More specifically, I looked at the price returns for the S&P/TSX composite index in the months immediately after the VIX initially troughed below 11. There were five times periods analyzed. The numbers may surprise you.

So the most recent time the VIX was below 11 was in mid-2014. We saw the VIX initially fall below 11 on June 6, and over the past month repeatedly dip below 11. Taking June 6 as the initial starting point, two months later, the TSX Index was 2.5 per cent higher, and three months later, the Index was up 4.9 per cent.

Prior to that, you have to go all the way back to 2006. The VIX dipped to 10.75 on October 13, 2006 and repeatedly bounced around the sub-11 level over the next few months. Using October 13 as the initial starting point, one month later, the TSX Index has rallied 3.4 per cent, and two months later, the TSX Index had a solid gain of 8.4 per cent.

Earlier that same year, the VIX bottomed at 10.74 on March 14, a month later, the TSX Index was up 2.3 per cent. The positive price momentum was short-lived with the index up just half a per cent two months later.

On Nov. 21, 2005, the VIX dipped to 10.82, one month later, the TSX Index was up 4 per cent, two months later, the TSX Index was up 7.3 per cent, and three months later had climbed 9.3 per cent.

Finally, July 2005.

On July 12, the VIX was 10.95, one month later, the TSX was up 4.7 per cent, two months later, the TSX was up 6.6 per cent, and was up 8.6 per cent by Oct. 3.

If history repeats itself, the dip in the VIX may suggest that the TSX is headed higher in the upcoming months.

More importantly, the fundamentals are supportive for the near-term positive price momentum to continue. For instance, we are finally seeing year-over-year earnings growth, resiliency in commodity prices and accelerating economic growth forecast.