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VIX PLUMMETS, BUY STOCKS?

20 May 2009 by Cullen Roche 8 Comments

The VIX fell below 30 today for the first time since the Lehman Brothers bankruptcy.   The slow drip downwards in the VIX is no doubt a positive for the equity markets, but we’ve recently seen an acceleration in the decline which could be foreshadowing a counter-trend move in the coming weeks.

vix1

The VIX is currently 34% from its 50 day moving average.  In the last two years since the recession began we have seen three other instances  where the VIX traded 30% from its 50 day moving average on the downside.  The first occurred in late September and early October of 2007.   The second occurred in May of 2008.  And the third occurred in mid-December 2008.   All three moves foreshadowed large equity sell-offs.  The first one in September of 2007 marked the top of the market.  The second market an intermediate top in the market after Bear Stearns went down and the third occurred just before the market sell-off in early 2009.

Clearly, three data points is not a comfortable amount of data with which to form a trading strategy, but there is no doubt that the sharp decline in the VIX represents a high level of complacency and comfort in high risk assets.  Considering the quick rise in the equity markets and the questionable underlying fundamentals and we might just be staring at a market that is ripe for a sharp decline.

Cullen Roche

Cullen Roche

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Comments
  • Onlooker

    It's really funny how the dropping VIX is being pointed to as a good thing for the market when it's clearly a contrarian indicator for market performance. Like the put/call ratio.

    But over and over you hear this lately. It should make people nervous and yet it makes them comfortable. Most just never learn, do they?

    05/20/2009 at 7:12 AM
  • James

    Didn't you buy the VIX earlier about a month ago?

    05/20/2009 at 8:24 AM
    • Cullen Roche TPC

      Pseudo tiny position, but yeah, I am losing money on it. The Yen gains more than make up for it. I am still not short equities, but looking to perhaps add some today…..

      05/20/2009 at 8:39 AM
  • Markep

    One thing to consider about the volatility of the stock market is that, given that equities can be thought of as an option on the assets of the corporation, what is fluctuating from day to day is the value of the total assets, not just the value of the equity. As the value of the equity approaches zero, small changes in the value of the assets will cause very large % changes in the value of the equity, hence we should expect to see higher volatility when equity prices are low. So, keep in mind, all else equal, lower stock prices will mean higher realized volatility.

    05/20/2009 at 6:51 PM