Trader’s Narrative

The continuous slow motion melting of the volatility index (CBOE’s VIX) has gotten a lot of attention lately. I briefly mentioned it last month when I pointed out that the VIX has shrunk to its lowest in 6 months. Now we are below 30 - which is not really an important milestone, except that it is a nice round number. And that we are now back where we were in September 2008 just around the time that Lehman Bros. blowed up good taking the rest of the market with it.

Here’s a long term chart of the VIX showing the significant support that it broke through to the downside:

While most people with some familiarity with the VIX automatically assume this means there’s a bull market around the corner, the truth is more nuanced. Here’s a zoomed in chart of the VIX showing that while we gapped lower and closed higher for the day, we still closed below 30.

My hunch is that there are two things happening right now. One is the always present movement of the VIX which is normal and derives from the options market. The other is the return to normalcy from an insane period of time. Believe it or not, there was a time that 30 was considered extreme. And yet, here we are approaching it from the other side!

According to Interactive Brokers: This brief analysis highlights the springboard rally for stocks as overly pessimistic conditions fade. As they do, watch for investors to overdo the volatility decline. As we keep noting, we’re still not out of the woods yet. Also, according to IB, there are 2.1 million VIX contracts expiring tomorrow with more than a third being calls (people betting that the VIX would go higher).

As Eddy helpfully pointed out:

Since 1990, when the VIX is below 15 (about 31% of the time), the S&P’s annualized return is 7.8%.
When the VIX is between 15 and 20 (27% of the time), the S&P’s annualized return is 2.8%.
When the VIX is between 20 and 25 (22% of the time), the S&P’s annualized return is -1.5%.
When the VIX is over 25 (20% of the time), the S&P’s annualized return is 11.1%.
To the extent there’s a tipping point, it seems to be a VIX of 13. Above 13, the S&P shows an annualized return of 3.0%, below 13 it jumps to 14.1%. However, 13 is a very low VIX reading; it’s been below 13 about 18% of the time.

Below is an CNBC interview with Carter Worth, chief market technician at Oppenheimer Asset Management. Worth provides some perspective by mentioning that the average level for the VIX since its founding is around 19. Watch the video to see why Worth thinks the VIX’s trend is about to change:

Also, check out Barron’s: Don’t Get Euphoric About a Falling VIX

As mentioned yesterday, the market tell everyone was watching today was the Lehman Bros. CDS auction. The results were not unexpected with the bidding coming in at just under 10 cents on the dollar.

The market continues to slide lower with the VIX volatility index reaching an eye-popping ~72%+

As I hinted yesterday, LIBOR may have topped because today it is down very slightly (at least it didn’t go up!). The overnight LIBOR rate is down to 2.47% from Thursday’s 5.09% - the chart below is for 3 month LIBOR. But the TED spread continues to creep up. What makes this wealth erosion devastating is that we are stair-stepping down in the stock market, rather than free-falling in full crash mode.

Something that has been pushed off the radar by the financial crisis is the dismal state of both Ford (F) and General Motors (GM). There was a time when Wall St. looked at GM as a barometer of the economic health of the US. The stock is now trading at single digit levels it was during the 1950’s when the Dow was trading at the 200 level.

Iceland, as you’ve heard, is now bankrupt and is listed on eBay. Their currency is worthless as banks refuse to even touch it.

Headlines are shouting: “The End of American Capitalism” and worse. Rothschild is purported to have said:

“It requires a great deal of boldness, and a great deal of caution, to make a great fortune.”

The trick is to be bold when everyone else is fearful and to be fearful when everyone else is bold. If you can do that, then come back and teach me.

If nothing else, all this will make for a great story for your grandchildren, in some Mad Max distopian future.