MorningWord 5/9/17: Bored Games (VIX)

by Dan May 9, 2017 9:38 am • FREE ACCESS

For all intents and purposes, the S&P 500 (SPX) closed at a new all-time high yesterday. The recent consolidation over the last two months is fairly impressive when you consider it did that during the legislative slowdown in Washington, the build up towards the election in France and Q1 earnings season. Stocks showed little sign of worry, and now with much of that out of the way, there is no overhead technical resistance, and support very close, back near the March / April lows at 2325:


The problem to my eye is not that European elections, or the legislative quagmire in DC, or earnings were a massive risk, it’s more that I can’t find a single investor who can think of a reason of why the stock market should correct.

The VIX closed yesterday at its lowest level since December 1993, in single digits, which says little about how low it can go, or how high the SPX can go:


Peter Boockvar over at the Boock Report offered some thoughts about the 25 year low, and some context around single digits prints in the VIX:

The VIX tells us nothing about where markets go in the short term as it’s just a scoreboard, but at the same time it’s easy to say that from this level the next 5-10+ points are up. It’s just a question of when and how much the stock market falls to cause that move (assuming it does). About 3 ½ months after that 1993 print it spiked to 24 and the SPX fell about 7% as the Greenspan Fed began what was to be an aggressive rate hike cycle. It revisited the low 10 level in late 1995 and the SPX fell 3% right after but then took off as we know the spectacular part of the 1982-2000 bull market was just beginning. We again saw the 10 level in 2005 but the market still had time to go on the upside even though Greenspan was hiking rates at every single meeting that year. The true delusion started to set into stocks when in late 2006 into early 2007 the VIX broke even below the 2005 low just as the credit markets were beginning to blow up. That was the height of complacency that was quickly shattered by late February ’07. Bear Stearns closed at a record high of $171.51 on January 12, 2007. By June of that year, the two internal mortgage based hedge funds imploded and Bear fell to around $150. I won’t rehash anymore.

So what’s the outlook now? If you believe that more rate hikes and quantitative tightening from the Fed, a form of it from the ECB as they taper, and tighter liquidity and forced deleveraging in China is no big deal, then don’t worry about a low VIX. If you believe as I do that it is a really big deal then understand that when the VIX historically has broken 10, it has rarely stayed this low for very long.

Peter’s point is not that a low VIX is somehow predicting a crash or crisis in the future. Just that it’s a sign (or a level of complacency) showing that no one sees any negative catalysts down the road. And how quickly that can change.

Steve Sears at Barron’s drove the VIX can’t predict point home in an interesting column last week Most VIX Analysis Is Outright Nonsense, about sentiment before and after what were important market moving events.  Sears makes a good point about being careful to extrapolate too much from a low VIX:

investor knowledge is lessened by scores of meticulously researched, data-centric commentaries that are often filled with so many charts and dates and inferences about the future and past that necromancers and tarot card readers likely study them for tips.

That’s in an important point. But this is what we do know. The VIX below 10 is in a lot of ways indicative of a market that’s become accustomed to buying the damn dip. We know that can’t last forever. And what’s wonderful about investors essentially abandoning protection and defined risk, is that it’s gotten really cheap for the rest of us.

While Sears makes the point that investors can’t trade the VIX that is quoted, CC on many occasions on the site has broken down how one can trade options on VIX futures (and how the pricing works) in his tour de force Volatile Compounds series (here). There will be a rush to the exits on stocks at some point. There always is. But defining risk and protecting your portfolio at these prices allows for participation in any new highs or breakouts without the fear of being trampled when someone finally yells fire.