Saturday, December 3, 2011


Two Possible Signals From the VIX
The drop below 30 may be bearish for now -- but bullish for 2012
Dec 2, 2011, 2:31 pm EST |
The CBOE Volatility Index (CBOE:VIX) often tells a more insightful story than the stock market itself, and now appears to be one of those times. In this case, however, it’s telling us two stories – one that concerns the days and weeks ahead, and one that may provide a preview of 2012.

First, the raw numbers. The VIX, also known as the “fear index,” spent Friday bouncing around in the 25-27 range, far below the 36 level it reached 11 sessions ago. This is great news for now, since it indicates that investors have become less concerned about Europe in recent days. But at the same time, this is also a level where the market has run into trouble during the past four months, in terms of both the VIX’s absolute level and the magnitude of the decline.

Regarding the absolute level, the VIX last traded into the mid-20s on Oct. 27 and 28. This signaled the high-water mark for the autumn rally, and it presaged a downturn of 5.2% in the S&P 500 Index during the next two trading sessions.

With respect to the size and duration of the move, the current decline in the VIX is nearing the danger zone that has signaled negative market reversals during the recent four-month period of market stress:

% Move

Aug 8 – Aug 17 48.00

Aug 19 – Aug 31 45.40

Sep 12 – Sep 16 43.18

Oct 4 – Oct 14 46.88

Oct 20 – Oct 28 36.87

Nov 25 -Dec 2 34.77

*Friday’s intraday low

From the standpoint of short-term trading, this table indicates that we’re nearing the time to take profits and get more defensive rather than ramp up on the risk.

From a longer-term perspective, however, the more important development is what happens when the VIX does make its next upward spike. At this point, 30 is the key level to watch: If the VIX can hold near or below 30 on the next market break, it may be a signal that it’s time to get more bullish.

The basis for this assertion is that in the past, a sustained move below 30 has signaled the beginning of extended bull market. The last two times the VIX rose above 30, stayed there for several months and then fell back into the 20s, the final move below 30 proved to be a very bullish sign. This occurred in mid-2009, confirming the post-crisis rally and setting the stage for a market upturn that lasted nearly a year. It then happened again in the third quarter of 2010, setting up the rally that persisted until the end of July of this year. Looking even further back, a similar move below 30 in 2003 signaled the end of the post-9/11 bear market and the beginning of a five-year rally in stock prices.

While the break of 30 in 2003 was a clean move, the two more recent moves were both messy processes that took a few weeks to play out. Still, the longer the VIX can hold below 30, the better the odds that 2012 will bring double-digit returns for equities.

Watch this level closely in the days and weeks ahead.

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