Light posting this weekend, but I came across two fascinating VIX graphs that demanded discussion.
The VIX, for those of you who may not be aware, is a function of option trading that deduces the "implied volatility" in the markets.
The first graph is from BCA Research, and it shows the VIX over the past 15 years:
Courtesy of BCA Research
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I read this as the VIX — eventually — becoming an attractive buy; I envision this scenario: the VIX spikes up to 13-14, before it runs into technical resistance; then as the market makes one last move upwards, it slides under 10. To me, the ideal entry point would be towards 8-9.
Those interested in seeing how the VIX trades should look at either the options (VRO) or futures (VBI).
Floyd Norris wonders if its due to "an excess of capital that feels it has nowhere to go but stocks. Individual stocks can still soar or collapse based on good news or bad, but money taken from one stock seems to flow to another, cushioning the daily movement of market indexes."
In today’s NYT, he writes:
"Back around the turn of the century, it seemed as if nearly every other day was an exciting one in the stock market, and not just in the United States.
At the peak of volatility in the United States, from 2000 to 2002, the Standard & Poor’s 500 showed a daily gain or loss of at least 1 percent for two days a week or more. And it was far from the most volatile market. In Germany in 2002, the average week had three big days.
But volatility began to dip in 2003, fell sharply in 2004 and absolutely tumbled in 2005. In the United States, there were 52 days in 2002 when the index showed a move of 2 percent or more – an average of one a week. That fell to 15, little better than one a month, in 2003. And there has not been one such day in the last two years.
The accompanying charts show that in Britain, Germany, France, Japan, Hong Kong and the United States, the amount of stock market volatility in 2005 was at the lowest level since at least 1996."
The chart included covers many of the major indices in the world:
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click for larger graphic
Courtesy of NYT
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Sources:
The Year Of Living Complacently
BCA Research, 09:54:00, December 20, 2005
http://www.bcaresearch.com/public/story.asp?pre=PRE-20051220.GIF
Don’t Hold Your Breath for an Exciting Day in the Stock Market
FLOYD NORRIS, Off the Charts
NYT, December 31, 2005
http://www.nytimes.com/2005/12/31/business/31charts.html
Major World Index VIX graphic
http://www.nytimes.com/imagepages/2005/12/31/business/20051231_CHARTS_GRAPHIC.html
“To me, the ideal entry point would be towards 8-9”.
Do you think it will go that low before turning up? Maybe?, and I hope you’re right. Friday I bought CALLS
The VIX is one of three indicators I watch. As of late it has a tendency to fill gaps within three days. Monday would be the third day. I do expect this pattern to change soon…so far so good.
I have a strong feeling we will retest the highs again, but i’m not betting on it yet. I wait for setups, clusters and breakouts.
THE WITCHES’ SPELL
Double, double, toil and trouble;
Fire burn, and cauldron bubble.
Fillet of a fenny snake
In the cauldron boil and bake;
Eye of newt, and toe of frog,
Wool of bat, and tongue of dog,
Adder’s fork, and blind-worm’s sting,
Lizard’s leg and owlet’s wing,
For a charm of powerful trouble,
Like a hell-broth, boil and bubble.
Double, double, toil and trouble;
Fire burn, and cauldron bubble.
-WILLIAM SHAKESPEARE
VIX is a measure of short term expected volitility in the stock market, and it’s experiencing a decade low. Too bad that there isn’t longer term data. It’s interesting that we’re seeing an inverted yeild curve at the same time. I take the low-flat yield curve as an indicator of long-term “certainty” in the bond market, as well, since it’s a one sided function (rates only go to zero, but up to infinity).
I find this low expected volatility bizzare looking at the longer term macro-picture of the world economy and demographics. Both measures look more like consequences following from the current monetary situation, than real leading indicators.
If so, is there a good medium term predictor for exchange rates? (money supply, interest rates,PPP)
On July 11th, I wrote this:
The date of the current low on the VIX is the same as the first reval — July 21st. Coincidence?
Whew thanks for rescuing me from Larry Kudlow-I knew there was a reason why God made me keep listening…
Volatility is cyclical – low volatility leads to high volatility and vice versa. This happens in all time frames from intra day to daily to weekly to monthly. The SPX’s high volatility during 2000-2002 is then followed by low volatiliy in the past 2 years. So my “guess” is the odds are high that volatility will return soon.
Whether high volatility will be accompanied by sharply rising or falling markets is anyone’s guess. The calm before the storm?
what is the impact on option pricing due to the change in the VIX?
http://simurl.com/tuhruf
History repeats. At the end of 1994, the VIX was low, the yield curve was flat and Chicken Little was squawking loudly.
The flat yield curve is forecasting lower interest rates. Some of the saviest investors in town are currently willing to lock in 4.35% for 5 years. Why would anyone do that? They must believe in lower rates.
The yield curve is forecasting a slower real GNP but real GNP is nominal GNP less inflation. GNP may slow only a little relative to the slow down in inflation.
The latest numbers show, head line inflation slowed while GNP stayed strong; Chicken Little squawked the entire time. If oil prices stay at $60 per barrel or fall to lower prices, head line inflation will exert downward pressure on core inflation. Core inflation is already getting hammered by productivity and globalization.
It is possible that we will see real GNP of better than 3% and inflation of less than 1% by the second quarter of 2006. The long bond could easily hit 4%. The FOMC might be cutting rates by July.
History repeats. February 1, 1995 the FOMC made the last in a long string of rate increases. July 6, 1995 the FOMC made the first of several rate decreases.
History repeats. The S&P 500 was up 34.1% in 1995.
I never control for a single variable:
Of course, 1994 and 95 were right in the middle of a huge bull market, with PCs and networking as driving technologies, and the internet in the hockey stick part of its growth.
In 2005, we are not in the middle of a Bull, but rather are in the middle of a trading range, coming 5 years post Crash.
Have a look at the chart here:
http://bigpicture.typepad.com/comments/2005/12/100_year_bull_b.html
Does 2005 or 06 look remotely like 1994/04?
“the VIX spikes up to 13-14, before it runs into technical resistance; then as the market makes one last move upwards”
Hi Barry,
I pay some attention to support/resistance levels for securities or even stock indexes, but I have a hard time imagining that the VIX follows technical analysis “rules”.
I can accept that psychological factors come into play when people are buying/selling stocks or securities, but I cannot imagine that the crowd is trading options based principally on the level of the VIX itself. They are more likely to trade based on the implied volatility of each of the securities.
We are partially in agreement on this — typically, a stock runs into resistance when it reaches a price where existing owners want to sell — hence, overhead lines on a chart indicate more supply.
But the VIX is a function of market activity, and while I haven’t tracked the exact mechanism, it seems to follow support and resistance levels — most likely through the pricing of options, and where the crowd perceives them as cheap or dear.
Those perceptions may (repeat MAY) show up as price levels in the VIX.
Perhaps its a coincidence, but I note the double bottom near 8-10
Agree whole heartedly with Barry’s last post. And, the VIX is not an independent variable. Instead it is highly correlated and linearly correlated to the equity markets. A regression analysis would surely show this but I’m too lazy to produce the facts. The VIX is simply another way of looking at the same data. It is a self fulfilling prophecy. Even short term. VIX gaps usually means the market has gapped too. One fills so the other fills. Support is reached and the VIX peaks. Resistance is met and the VIX bottoms.
I also see no correlation from 1995 to today in terms of the economic cycle, equity cycle or anything else of the sorts. It’s quoted by bulls because it is the only recent analysis they can show where their case for a higher maket is supported. And it may work out that way…..eventually. But it won’t be because there is a high degree of correlation. It’ll be dumb luck.
But, I see a correlation from 1929 to 2000. Dow in 29 and Naz today. Similar excesses likely build in equity bubble situations. If so, we are going to have some rocking stock years. That said, economically, we are not seeing a repeat of 29. So, do we blame Greenie for being an inflationist after the equity bubble or do we praise him for saving us from a repeat of the economics post 29? Or, is the answer more gray? Remember, Greenie had a few other advisors Fed Prez’s to assist in decision making. Uh…like thousands of people. He’s just the talking head. Btw, how’d he marry his wife, Andrea Mitchell? She’s sorta hot and young enough to be his daughter. He must have quite a policy. A fiscal policy, that is.
Surprising how many people want to believe the worst can happen with this economy. Gold bugs, deflationists, inflationists, debt mongers, etc. There’s almost an infatuation with crisis and disaster. A desire to see their prophecy come true. It’s the same reason we loved watching America bomb Iraq, dropping nuclear bombs on Japan in the first Iraq War. It’s the same reason we are intrigued by the devastation with Katrina and the tsunami disaster. There is a clear reason for this psychology that I won’t get into but it’s no different than the psychology that keeps us from seeing crisis that it hammers us on the head which Barry talked about earlier.
And there is enough pessimism to drive the market higher…..eventually. There are two forms of sentiment at work here. Short term, there is an extreme bullishness. That can be wiped out relatively quickly. But, there is a longer term tremendous pessimism. Debt, war, China destroying America, housing bubble, everyone working at Wal-mart, Misery Index Barry pointed out, low sentiment numbers of our public policy makers, under employed economy, post 9/11 risk premium, etc. It’s so doggone thick I sliced it and put it in a sandwich today. The long term wall of worry is in place. I just saw Rita Hayworth on TV. Geez, was she hot! I’m too young to remember that. :)
The good news is whether the Fed policy is destructive or constructive, they are patriots first and foremost and they will do damn near anything to keep those outside-the-bell-curve scenarios from happening. Hence, the gloomers and doomers will likely blame any good economic news on manipulation and Bernanke the helicopter pilot coming to the rescue while continuing to devalue the dollar. Much of which happened when we went from the Gold/Silver standard to the Gold Standard but will continue to happen and has been happening for nearly 100 years. Oh Chicken Little.
I’m not a perma bull and I’m not a perma bear. I am aware that cycles happen and trends never last forever. Americans will begin saving again. The trade deficit will correct one day. The stock market will correct. When? Hmmm…..when is the next major earthquake in California? Impossible to predict. Inflation will come back and the VIX has likely bottomed after years of decreasing volatility.
And for those who predict doom and gloom and trillions in debt, remember that we won’t continue at this pace. But it may come to some type of mini-crisis before it changes direction. That is how our government is set up to work and that is what it takes to do the heavy lifting. The founding fathers were smart. Keep them squabbling in all times except crisis so they don’t create more of a mess than is necessary. Those who spew our debt problems also fail to quote that our personal and public debt is no higher than it was twenty years ago as a percent of personal income or GDP. And, they fail to mention the expected $150 trillion in tax revenues during the same time line where they quote Social Security going bankrupt. Are there problems? Sure. Will they be addressed? Yes. Will you have to work longer? Likely. No more government retiree programs at 55 either. And, if a world financial crisis does occur, who is going to come out smelling the rosiest? I’d say the country with the most flexible economy and the most wealth. Far and away good ole America.
Just a little Sunday morning rant to help Barry generate more posts! lol. The VIX is likely ready for a party and soon. But, we WILL go up next week. Short term work argues an extremely high probability of it.
Nobody has mentioned the role of the passive investor — e.g. the index-ation and etf-ization of equity assets (not to mention program trading) — and the dampening affect that this has had on the VIX. This has been huge and makes any general statements about cycles and how the VIX has behaved in the past moot. If you dissect the data you will see that there has been a pardigm shift (egad sorry for bringing that phrase up..) since 2001, beginning in 1998, the last period of real and lasting equity vol.
Indexing was huge in the 90s — so its not that.
ETFs are not measured in the VIX — its the options trading on stocks in the S&P500
theoretically, they may be pulling some investors away from individual names — so there might be a smallish impact there
I would guess that Program trading would be adding to volatility, not dampening it
Equity markets: Low volatility cannot last
In late December BCA Research published a short piece, The Year of Living Complacently, which highlighted the very low equity market volatility in 2005:The growing influence of hedge funds, abundant liquidity, robust corporate health and low inflation …
Neither VIX futures nor VIX options are a proxy for spot VIX. In fact you cannot properly watch any instrument to “see how VIX trades” for the simple fact there are no non-exotics that allow a straight trade on spot VIX. Frankly, VIX futures are already a kind of exotic (and should be treated with due care) since they’re a derivative of a derivative of a derivative.
In 1994 nobody “knew” we were in the middle of a huge bull market. That knowledge only came long after. The exact same thing could happen here – it sure doesn’t feel like a bull market right now, but a 50% Dow move over 2 years would change the hindsight perceptions in a hurry.
“I would guess that Program trading would be adding to volatility, not dampening it”
A lot of program trading is either direct or implicit dispersion trading, which lowers the implied volatility the index components trade at. This in turn lowers VIX.