The S&P 500 Volatility Index, or VIX, is a measurement of the market’s combined expectations for price changes in the S&P 500 (SPY) in the short term. While controversial as a measurement, it is valuable for traders and risk managers for one reason: it reverts to its mean in a very short time after temporary spikes.

Over the last 5 years, the VIX’s 30-day SMA has steadily fallen from around 24 in 2010 to the low teens in 2013 and 2014. In 2013, market participants were noting the historically unprecedented low levels of volatility in the marketplace, and expectations were that volatility would return when the Federal Reserve’s bond program began to taper in 2014.

However, we have seen volatility fall even further. The SMA has gone from over 14 to over 13, and the VIX fell to 10.28—one of its lowest ratings in history—in the middle of the year. Meanwhile, spikes have gone lower—at its peak in early February, volatility rose to 21,but it hasn’t gone above 20 since then, which has recently been considered its peak. In fact, its peaks in March, April, and August were below 18, with August’s market correction yielding a VIX peak of 17.03.

This means that, despite expectations for more bearish corrections in the market and especially in the popular press, actual options-based activity suggests that, in fact, traders are not expecting a bearish market anytime soon. The growth in volatility in recent weeks, with the VIX peaking at 16.71, has led some analysts to say that October is going to become a bearish month, and a correct of 5% or more is in the cards.

Meanwhile, the S&P 500 is showing enough weakness to confirm this view. SPY was down over 3% for the month by the closing bell of a flat Thursday, erasing many gains and falling far from the psychologically important 2,000 level.

But the bullish channel has not been broken. SPY is up over 5% for 2014 so far, with a P/E ratio of about 19.3.

As we enter earnings season, investors will be looking at three key trends:

  1. The taper’s impact on cash flows. With the taper done in October, investors will worry that capital flows will stop going into stocks and could go elsewhere as yield becomes easier to find, and risks to stocks rise. Others disagree, arguing that the stock market is strong enough on its own thanks to healthy earnings growth and a recovering macroeconomic environment for U.S. companies.
  2. That brings us to our second point of concern: share buybacks. While buybacks are one way of lowering P/E ratios by reducing outstanding stocks and boosting EPS, buybacks are expected to slow with the taper, as companies face higher borrowing costs and less capital looking for investment in the corporate bond market. If buybacks slow in the third quarter as companies announce their earnings, investors could get cold feet and lower exposure to stocks.
  3. Revenue growth. U.S. GDP was very positive in 2Q, and expectations for 3Q are a tad cooler, but still strong. Greater GDP should mean greater revenue growth for U.S. companies, which should help EPS with a much healthier form of growth. Revenue growth for many companies has been disappointing since 2009, but a change in this trend this quarter could signal that companies are finally ready to grow shareholder value without the Federal Reserve’s training wheels.

We do not know if those trends will materialize or if investors will be disappointed, but in any case, this earnings season is unusually important for investors who are trying to get a hold on how the U.S. economy is developing. With stronger earnings results, we could see the recent VIX spike ebb and the index will return to the mean. Without it, another spike could come before the new year.