Friday, March 12, 2010

VIX Showing a Lot of Optimism but Is not Necessarily Signaling a Market Top

The S&P 500 volatility index, VIX, more or less hit new lows for this move, closing at 17.66. What the VIX actually measures is more complex than the common interpretation, which is that is acts as a fear index. At the peak of what now looks to have been a credit bubble, the VIX briefly went under 10, which was perhaps as extreme a sign of optimism as the post-Lehman panic highs in the VIX were signs of fear.

A 5-year snapshot of the VIX is shown; click on it to enlarge.
Also shown is a Yahoo/Finance chart of the VIX since 1988.

The prior pattern has been for a post-recession multi-year drop in the VIX, followed by a turn upward before the next recession.
The VIX has correlated very well with the Fed funds rate with a substantial lag, perhaps up to 2 years.

This correlation is well known and emboldens the bulls.
My sense is that this trend is your friend till it is not. Numerous stocks look rich on various measures; others look OK such as those mentioned here recently (TJX, for example).
Overall, though, my sense is that this labor market is much less V-shaped than is GDP. For whatever reason(s), I suspect that uncertainty over the Obama agenda is contributing to a freezing of hiring in small business, which has plenty of business reasons to be cautious anyway.
With the S&P 500 having a dividend yield about 2%, I have this nagging sense that people who are not good stockpickers will ultimately do as well purchasing 3-5 year secure debt obligations and buying in when the VIX finally moves up. It won't matter, unless dividends soar, if the indices soar on speculative buying. There is a lot of drop that can happen again, either in absolute numbers or adjusted for whatever inflation is coming.
Now that the VIX is finally reported on the CNBC ticker, it is guaranteed to be less useful as a tool in understanding the stock market than previously. It is not, however, anywhere close to a household index, so it still makes sense to time one's stock portfolio by using surges up in the VIX to buy and big drops to sell. If in March or April the VIX drops to 15, selling in or before May and going away till it at least moves up to 20 may be a smart strategy for non-core positions.
In other words, we of course may be at a market top, but the VIX is merely in a zone which has allowed multi-year advances in stock prices and should not be used as more than a timing tool.
Copyright (C) Long Lake LLC 2010

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