Improving signs for the stock market

The VIX measures the implied volatility of a range of S&P 500 options over the approaching 30 days, and is broadly used as an indicator of the market’s expectation of price volatility over the next month. This index is more accurately understood as an oscillator, with a mathematical expectancy of ‘mean reversion’. That is, although the index will fluctuate between ‘high’ or ‘low’ readings, it will revert to its mean, or average, level once it has peaked or troughed. This mean reversion reflects the market’s long-term expectations of volatility. Even in extremely volatile moments of market crisis, time and information tend to deflate investor anxiety; even in the calmest moments of complacency, the future invariably delivers market crisis. This is one of the truths of the investment world. It is a truth in life, too.

 

 

 

 

 

 

Now that the VIX has returned to its mean level, how meaningful is its current Bearish Crossover indicator? If we look at the record of the past 16 years, the market has showed intermittent correlation with VIX Bearish Crossovers. The table below shows the performance of the S&P 500 index after the VIX turns Stock Trends Bearish with a Bearish Crossover  until it returns to a Stock Trends Bullish trend as a Bullish Crossover .

 

Of the 13 previous VIX Bearish Crossovers during the period - which would represent times when the intermediate trend (13-week average) of the Volatility index had returned back to its long-term average level (40-week average) – three VIX Bearish Crossovers were followed by significant positive returns for the S&P 500 index. Although the VIX Bearish Crossover signal was also followed by three significant drops in the S&P 500, in one of those occasions (June 15, 2001, prior to 9/11) the VIX Bearish Crossover was matched with an established Bearish trend for the S&P 500. The other occasions, January 4, 2002 and May 16, 2008, preceded major market collapses.

 

Overall, the inverse correlation of the VIX Bearish Crossover  as a market-timing indicator appears substantiated when the matching S&P 500 trend is either Bullish or Weak Bearish - as it is now. The current market conditions – supremely affected by the far-from-resolved Euro crisis and the U.S. election cycle – suggest that this recent lull in market anxiety will be positive for equities. The VIX tells us now is the time to be in stocks again.

 

 

Date	VIX ST Trend	VIX Price	S&P 500 ST Trend	S&P 500 Price	S&P 500 % Chg
10/11/96		15.51		700.66
12/13/96		22.26		728.64	4%
2/20/98		19.55		1034.21
8/21/98		31.91		1081.18	5%
1/08/99		23.88		1275.09
2/18/00		28.45		1346.09	6%
8/04/00		21.54		1462.93
11/24/00		29.58		1341.77	-8%
6/15/01		26.33		1214.36
9/28/01		35.19		1040.94	-14%
1/04/02		22.02		1172.51
7/12/02		38.33		921.39	-21%
1/10/03		27.13		927.57
5/13/05		16.32		1154.05	24%
7/15/05		10.33		1227.92
10/21/05		16.13		1179.59	-4%
12/02/05		11.01		1265.08
5/26/06		14.26		1280.16	1%
10/13/06		10.75		1365.62
3/30/07		14.64		1420.86	4%
5/16/08		16.47		1425.35
9/19/08		32.07		1255.08	-12%
4/17/09		33.94		869.6
5/28/10		32.07		1089.41	25%
10/01/10		22.5		1146.24
7/29/11		25.25		1292.28	13%
1/20/12		18.28		1315.38