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FT Alphaville highlighted a note from Gain Capital this morning regarding the divergence in the VIX and the S&P:

Vix and S&P: Something’s gotta give?

The VIX index (which measures volatility in the S&P) has stalled at the 21.50 mark this week while the S&P has moved higher. The Vix and the S&P usually trade inversely to each other – since March 2009 the two have a fairly strong inverse correlation of -0.66, so as the Vix falls the S&P rises and vice versa. However, since the 22 October 2010 the two have been moving in the same direction, turning the correlation positive. This is extremely unusual. Over the last decade the correlation between the Vix and the S&P has been -0.6.

What’s going on here?  Of course, bond market are reacting similarly.  Investors often view the smart money as being the credit and options markets, but in recent weeks its been the equity markets that have looked smart.  Gain Capital is right – something’s gotta give.  With double dip priced out of the market, QE2 being seen as a savior and inflation now a major concern (at least for risk markets) it looks to me like the ones hedging via fixed income and volatility are likely playing the prudent hand – even if it might not end up being the right one.

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