The CBOE volatility index (VIX) has been trading in a moribund trading range downwards for the length of this cyclical bull market. Recently it scraped the bottom of the channel when it traded down to an intra-day low of 15.23%.
But with the news of Greece’s downgrade from Standard & Poor’s the market tumbled and the VIX spiked higher. By the way, is anyone curious as to why the market is suddenly listening to rating agencies? These were the same firms who slapped AAA ratings on sub-prime mortgages, more than 90% of which have descended into junk status now.
So refresh my memory, why exactly should anyone care what rating agencies think? Why are they moving markets instead of being charged for fraud? After all, deals like the infamous ABACUS simply could not have happened without their explicit consent.
Getting back to the VIX: it spiked on Tuesday April 27th 2010 to the highest one day change (30.6%) since October 22nd 2008 (31.1%). Of course, in contrast to today’s subdued volatility levels, it was trading at 70% back then. These extreme spikes are very rare, having only occurred 8 times during the lifetime of the VIX index (including this most recent example). Usually they coincide with structural events that trigger widespread panic. For example, the Asian financial crisis, the 9/11 WTC attack, the 2008 credit crisis, etc.
As Bill Luby suggests, the smart thing to do is to fade these volatility spikes. The corollary, as this chart shows, is that it has also been smart to go long equities:
What you are looking at in the above charts is the S&P 500 for the duration of the most recent cyclical bull market compared to the relative distance of the CBOE volatility index to its own simple 50 day moving average.
I’ve mentioned the idea of looking at the relative VIX before. The advantage is that we smooth out the distortive effect of periods, like the current one, where the index moves to an extreme level, thus making comparisons to the past difficult. Instead of looking at the nominal level, this method allows us to compare the current reading to the most recent trend and identify spikes more clearly.
It isn’t a perfect correlation but usually when the relative VIX spikes and then falls lower, the S&P 500 makes an intermediate low. This short term guide can be coupled with the technical rationales we’ve already discussed for the primary trend: Technical Reasons for More Stock Market Gains.
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