SVOL - The Dangers Of Falling Prey To VIX-Ation
2023-08-17 10:45:00 ET
Summary
- A lower level of the VIX index would indicate expectation for low volatility in prices, while a higher reading would indicate greater volatility.
- For some reason, there are people making the bear case who equate a low number with an imminent market correction. A look at the record would indicate that this is simply not the case.
- Risk is the investor's constant companion. the risk of things going wrong and the risk of things going right. Even after a prolonged period of better-than-expected economic news, skepticism reigns supreme.
VIX-ation and its perils defined
I define "VIX-ation" as an overdependence on using the CBOE Volatility Index as a market indicator. "The CBOE Volatility Index ( VIX ) is a real-time index that represents the market's expectations for the relative strength of near-term price changes of the S&P 500 Index (SPX)." (Source: Investopedia ) The operative words in the definition are "real-time." The time frame here is 30 days. A lower level of the index would indicate expectation for low volatility in prices (calm), while a higher reading would indicate greater volatility (fear). For some reason, there are people making the bear case who equate a low number with an imminent market correction. They believe it is a sign of complacency (as opposed to confidence), investors falling asleep at the switch. A look at the record would indicate that this is simply not the case.
A review of this interactive chart (Source: Yahoo) should disabuse anyone of that notion. The long-term average level on the VIX is about 20. An examination of the chart will show periods where the index has been below that level for months, maybe a year or more. These intervals have coincided with some very good markets. On the contrary, when the VIX has exploded higher (say 75 or 80 on the index), it is usually the result of a financial shock, the 2008/2009 financial crisis or a black swan event like Covid-19. Some will disagree with my labeling the pandemic as "black swan". Regardless of the warnings about a pandemic, it still felt to me to be totally out of left field. For many of us, 2007 and 2008 were just as surprising. These fear spikes turned out to be great buying opportunities. Since the bursting of the tech bubble in 2000, there have been many periods of sub-20 and even sub-15 VIX readings. The S&P 500, during that 23-year period, has gone from 1550 to its current level of 4464 (all-time high, 1/04/2022 = 4818). Forget the notion that a sub-20 VIX is a harbinger of bad things to come.
"The Stock Market Is Falling. Why It's Time to Get Happy"
" The Stock Market Is Falling. Why It's Time to Get Happy " is not my own creation but the work of Ben Levisohn in the August 11 issue of Barron's (you will need a WSJ or Barron's subscription to view).
Levisohn posits, "This columnist, too, can get, well, stuck thinking about what can go wrong for the markets - and the world. When stocks are falling, as they were last year , it's easy to remain tied to a bearish position despite signs of a turn, or to dismiss a gain as nothing more than a bear-market rally. There are so many risks these days - from bank failures , an aggressive Federal Reserve, and still-too-high inflation to geopolitical tensions with China, war in Europe, and catastrophic weather-that we want to apply for membership among the esteemed permabears of the world."
He points to comments by Savita Subramanian, head of U.S. equity and quantitative strategy at BofA Securities: "Sentiment has shifted from abject fear and loathing to something a bit warmer," she writes. "But skepticism reigns."
However, based on real-life experience over the past two decades, Levisohn asserts, "persistent gloom is a lousy way to make money in the stock market..." Remember, the S&P 500 tripled during the last 23 years, a period fraught with risk and disappointment.
Interestingly, Levisohn does not tie the article together with the reason we should "be happy" other than the market, over the long term, generally rises. I will endeavor to close the loop referring back to my last post .
The economic news continues good despite a 525-basis point increase in the federal funds rate in the past year and a half. Inflation is abating. We added 187,000 jobs in July. The unemployment rate dropped back to 3.5%, and wage growth on an annualized basis came in at 4.4%.
Regardless of your market opinion, risk is the investor's constant companion... the risk of things going wrong and the risk of things going right. Even after a prolonged period of better-than-expected economic news, skepticism reigns supreme. As I have pointed out previously, quoting John Templeton's secular bull market stages (fear, skepticism, optimism and euphoria), we are still firmly in stage 2 (the second quarter of a four-quarter game).
Changing investor mindsets
Getting to stages 3 and 4 may take some time. American sociologist and behavioral economist, Daniel Kahneman has thoughts on why this may be the case:
"There are studies showing that when you present evidences to people they get very polarized even if they are highly educated. They find ways to interpret the evidence in conflicting ways. Our mind is constructed so that in many situations where we have beliefs and facts, the beliefs come first. That's what make people incapable of being convinced by evidence. So education by itself is not going to change culture. Critical thinking through education is very slow and I'm not very optimistic about it."
One saving grace for the stock market is that it is the only place I know where higher prices seem to create demand. (Don't confuse me with the facts... I need to own stocks!)
Regardless, we see Kahneman's thought process at work in our political miasma and in the stock market, where there continues to exist a legion of cautionary to downright bearish voices in the face of much-better-than-expected economic and stock market results. These opinions and voices are formed by the media they consume. My advice, look for the verifiable facts and don't let the naysayers dictate your investment approach.
What's your take?
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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The Dangers Of Falling Prey To VIX-Ation