Stop Wasting Energy On The VIX [Dow Jones Industrial Average(INDEXDJX:.DJI)]

technical bounceChris Ciovacco: Stop Wasting Energy On The VIX.

  1. The VIX Fear Index is arguably the most over-analyzed tool on Wall Street relative to its real-world predictive powers of where stocks are headed.
  2. The common argument is when the VIX spikes, it is indicative of rising fear, and thus stocks typically drop when the VIX rises.
  3. The VIX measures “expected volatility”, which is quite a bit different than fear.
  4. Can stocks go up when the VIX rises significantly from low levels? You can decide for yourself after reviewing a historical example.

Sounding The Low VIX Sirens For Stocks

If you follow the markets regularly, you have probably run across similar passages to the one shown below from a May 28, 2014 MarketWatch article:

As the VIX continues to sink closer to its historic low of 9.39, many commentators are now discussing the VIX as a “complacency index.” As the VIX falls, it signals increasing levels of investor complacency. Because economist Hyman Minsky taught us that periods of high volatility follow periods of low volatility, many investors are beginning to worry that a “Minsky moment” could be lurking around the next corner that would send volatility higher, increase the risk premium for holding stocks and cause prices to sink.

GDP Aligns Nicely With The VIX Story

Having worked on Wall Street for over 20 years, we can confidently state that you can always find a bearish narrative that sounds logical. The same can be said for a bullish narrative. Those reading from the bearish script got a nice rewrite Thursday in the form of revised gross domestic product (GDP) figures. From Bloomberg:

Less is more for the U.S. economy, which suffered its first contraction since 2011 last quarter. Gross domestic product fell at a 1 percent annualized rate, worse than the most pessimistic forecast in a Bloomberg survey of economists, revised Commerce Department figures showed today in Washington.

Low VIX Means Trouble For Stocks, Right?

The VIX is currently close to a historic low. If that means historic complacency, then logic would tell us that when the VIX rises from very low levels, it must mean rising fear and bad times ahead for stocks…right? That logic often holds in the markets, meaning the VIX can be and is a useful tool for stock investors. However, the strength of a stock market indicator lies in its consistency. Can stocks rise as the VIX rises from low levels? History not only says “yes”, but it does so emphatically. The chart below shows a period beginning in late 1995 when the VIX started to rise from low levels. The VIX surged from 10.36 in 1995 all the way to 38.20 in late 1997, which is a major spike in the VIX. How did stocks perform over the same period? The S&P 500 gained 47%…yes, that is not a typo…stocks gained 47% during a period when the VIX more than tripled.

For those scoring at home, the 47% move in stocks began when the VIX showed “a high level of investor complacency” with a reading of 10.36. What was the recent 2014 low in the VIX? 11.36, which is quite similar to 10.36.

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