Wall Street's fear gauge is crashing toward a 4-year low. That could be a sign of overconfidence, UBS says.

• The VIX index, which tracks stock-market volatility, is trading close to a four-year low.
• That could be a sign investors are complacent about the economy, according to UBS.

Wall Street's so-called "fear gauge" is plunging a four-year low – and that's a sign stock-market investors have become overconfident, according to UBS.

The Swiss bank said in a research note last week that the tumbling VIX Index, which measures stock-market volatility by tracking S&P 500 options contracts, suggests traders have become complacent about the economy.

"At present, markets are priced for this optimal outcome," strategists wrote, referring to the scenario where the US avoids a recession but the Federal Reserve still starts cutting interest rates in 2024.

"The VIX index of implied US equity market volatility, a popular measure of fear in markets, is close to historical lows – pointing to a degree of over-confidence, in our view," they added.

The VIX has tumbled 28% this quarter, according to data from Refinitiv, meaning it's closing in on its lowest levels since 2019. The S&P 500 has climbed 8% over the same period, powered higher by cooling inflation and resilient growth.

The slump in volatility is a sign investors have put too much stock in the idea 2024 will bring about a "Goldilocks" outcome where inflation cools, the Fed starts slashing borrowing costs, and the economy is able to dodge a long-expected recession, UBS warned.

"Economic data will need to walk a fine line in the coming months to sustain the recent rally," the strategists wrote. "While we expect stocks to sustain recent gains and advance modestly higher in 2024, equity markets are already pricing in plenty of good news."

"As a result, we expect a return to more normal levels of volatility."

The Swiss bank believes the S&P 500 will finish 2024 trading at around 4,700 points – just 1% higher than the level it traded at as of Tuesday's closing bell.

UBS's prediction of limited upside makes it significantly more bearish than much of Wall Street, with top strategists including Bank of America's Savita Subramanian and Deutsche Bank's Binky Chadha forecasting that the benchmark index will roar to record highs next year.