Extreme Volatility

Like our prior set of charts, the following VIX graph from Birinyi Associates discusses a measure of sentiment hitting an extreme measure — they call it "extreme volatility."

How is that defined? Anytime the VIX doubles over 50 days:

"Over the last 50 trading days the
CBOE Volatility Index (VIX) is up over 100% which is an occurrence we
have seen in only five other periods…The chart of the S&P 500 highlights the first day of
each of the prior periods where this occurred. Each of these prior
occurrences have coincided with market weakness, which was then
followed by positive returns."

Let’s look at their chart, which I annotated below:

The first two of these 5 examples of extreme volatility may have been followed by positive returns, but they didn’t lead to a significant snapback anytime soon (left side of graph, un-numbered):



However, the 3 most recent prior examples of extreme volatility did, and I have annotated them with numbers 1, 2 and 3 (This week’s example is marked "?").

Here’s how they break down:

Point 1: August 1998 Sell off (due to LTCM blow up) led to much more upside

Point 2:  post 9/11 Sell off led to a 40% plus Nasdaq rally, which ultimately failed and made new lows

Point 3: Late 2002 lows, led to a small pop, and a successful retest pre-Iraq Invasion

Point ? is this week.

Note that the prior 3 VIX events all had a response from the Fed of massively increasing liquidity: Rates were lowered, money supplies were increased. However, at present, liquidity is being removed from the system — not added. That is consistent with our expectations for a small bounce 3-6 weeks,  and not the beginning of a brand new cycle.

Short term, this VIX move looks parallel to three most recent versions; Longer term, however, I suspect it will have less legs than the 1998 or 2002/03 versions.


For some background on this, look at our December 2005 discussion Death of Volatility, and the more recent January 2006 calls to "Buy Volatility."

Print Friendly, PDF & Email

What's been said:

Discussions found on the web:
  1. Bob_in_MA commented on Jun 15

    I just read about that in the WSJ and came here because I wondered what your response would be. You make a very good argument.

    I think this is one of those stats that leads nowhere. If you restrict the measure to x number of months the market went up y %. The value of x is chosen by determining whatever results in the highest y. More self-affirming data mining.

    I’m not convinced things will get as bad as you predict, but the more I hear from the bulls, the more cautious I become.

    There’s another piece in the WSJ today about emerging markets being much better positioned financially now than they were in 1998. Which is obviously true. But the present problem is not their finances but their dependency on American demand for their exports. There won’t be a melt-down, but that’s not a reason to put money in markets that are still up 60% in the past two years and have the prospect of tightening margins.

    The bulls seem to be throwing every possible justification out there hoping a few prove true.

  2. James Dailey commented on Jun 15

    The Fed is NOT reducing liquidity – that is a popular misconception that is NOT backed up by the facts. Over the past several weeks, there have been multiple coupon passes injected into the money markets and all types of credit (business loans etc) have been ACCELERATING over that time frame. Interest rates are but one tool in the monetary kit, and the Fed is blasting liquidity through the back door. Now, other central banks appear to be less reckless than our own and it now appears that THEIR actions are starting to suck REAL liquidity out of the global money markets – with the Japanese the most prominent at this point.

  3. Franky_in_Philly commented on Jun 15


    Can you provide the links to the data you are alluding to? I am very interested in acquiriing any good source of material on that topic.


  4. me2200 commented on Jun 15

    Something HAS TO be done about speculation in commodities. I don’t know who has the power to tackle this problem, but our economies are getting wrecked by speculators for no good reasons.

    Example: natural gas. Today’s inventory report comes out light 77 versus 88 and natural gas spikes up to $7.70. We have so much inventory in natural gas that it is unreal. There is absolutely no possibility of a shortage.

    Furthermore, in spite of huge inventory, the price of natural gas didn’t fall like it should have. In years previous to this, natural gas inventory levels like these would have the price down at $2-3, not $6.

    I blame this all on speculation. Pure and simple.

    If BB wants to get inflation under control, all he has to do is kill the speculation in commodities. That will be the end of our inflation problem.

  5. EKC commented on Jun 15

    PPT at work again? Amazing there is no public outcry about this.

  6. me2200 commented on Jun 15

    Are you being sarcastic or serious ?

  7. C commented on Jun 15

    “I blame this all on speculation. Pure and simple.”

    You hit the nail on the head. I wonder if BB alone can really kill it, though.

  8. me2200 commented on Jun 15

    An 8% Fed funds rate with real tightening would kill it. It will kill housing too. But I don’t see how you can kill one without killing the other. Without doing something drastic and non free market, that is.

    I’ve always wondered what the price of oil would be if they limited the players to those that just actually produced the physical commodity and those that used the physical commodity ? Ie, if you didn’t have a tank to store oil in, you can’t trade… what would the market look like then ?

    As it is right now with supply being a bit tight, commodities are a one way trade. Higher. As soon as there is any bullish NEWS in the market, the sellers raise their prices.

    Look at natural gas last winter. Truthfully, there was never any risk that we would go short of natural gas. Inventories were always good. And natural gas is not a substitute for oil. And foreign politics play no part whatsoever in the domestic price of natural gas because they can neither supply nor consume.

    So… why was natural gas $15 last winter ? Why did it only fall to $6 this spring ? We are practically swimming in the stuff.

    To me this smacks of Enron and California and electricity. Somehow the market is extremely biased.

  9. Required commented on Jun 29

    “I’ve always wondered what the price of oil would be if they limited the players to those that just actually produced the physical commodity and those that used the physical commodity?”

    Perhaps lower, perhaps higher. You should really be wondering how the rest of your life would be different if such limits were imposed. You’d then understand how naive comments like that are.

    Who is the user of the physical commodity? I drive a car, do I not use oil? I heat my house, do I not use gas? What are you saying, that only the corporations who sell me the gas should be able allowed “players”?

Posted Under