January 17th, 2013

Debunking the VIX Myth …. Again

imageI’ve had enough of this and it’s now time to again debunk the VIX myth.  This isn’t a new campaign of mine and have written about it here before:

  • In Debunking VIX Predictive Value of December 18, 2010, I compared the VIX on each of those 2,387 trading days (6/22/2001 and 12/18/2010) against the change in the S&P 500 Index over the following 30, 60, 90 and 180 days.
    • The VIX has been below 20 nearly as many times as it was above; when VIX was below 20, the market has risen 53% of the time, regardless whether over 30, 60, 90 or 180 days.
    • The VIX has been above 20 52.6% of the time and the market declined 61.7% of the time whether over 30, 60, 90 or 180 days.
  • In Ignore The VIX As A Market Trend Indicator of March 17, 2010, I included a chart that had both the VIX and the S&P 500 Index and wrote:

    “True, the VIX had an inverse relationship with the Index during 2008-09, but throughout the long 1986-2000 bull market, the VIX trend bore little connection with the Index having trended down and then up (indicated by the solid blue 300-day moving average) during most of the period…Falling VIX is interesting but I welcome it rather than finding it something to be fearful of.

  • In Does VIX Inform or Mislead? of October 2, 2008, I reacted to everyone’s call that a VIX in the 40’s (then unusually high) indicated that a bottom was near.  I wrote that “the VIX is a crude instrument and may be good at anticipating a short-term bounce but, until it hits extreme values (50 or more), it gives false indications that a bottom has been reached. Today, the VIX closed at a value of 45.26. I wouldn’t bet that we’ve touched bottom yet; a bounce perhaps, but not a bottom.”  My Market Momentum Meter indicated that the market was still far from having bottomed and, actually, would actually decline another 39%over the next five months to the true bottom on March 9, 2009.

We’re again hearing that the VIX is at all-time lows leading to diverging conclusions.  For example, a few days ago, the American Enterprise Institute in their blog wrote that “the VIX Index closed today at 13.45, the lowest level since May 2007, more than five years ago, and more than six months before the recession started in December 2007.  Investor fear in the stock market has been consistently subsiding, and market volatility is now back to normal, pre-recession levels.”

On the flip side of the coin, there are those who are contrarian investors and believe that a low VIX indicates too much complacency whish in turn leads to a market top.  For example, one blogger recently wrote “The VIX is the best measure of Fear in the market. Fear just hit 5 year lows and is about to hit its long-term lower trendline. Each prior lower trendline visit over the past few years predicted a fairly substantial market collapse in the ensuing weeks…..”  And Fox Business News summed it up by this interview of Bespoke Investment co-founder Paul Hickey on the outlook for the markets.

Let me take another cut at getting to the truth about the VIX.  In short, it is a lousy indicator of both near- and long-term market direction.  This time I did a statistical analysis and discovered that there’s very little correlation between the level of the VIX on any given day and where the market will be 50, 100, 200 or 300 days later.  I went back to April 6, 1998 and compared the value of the VIX on each day with where the market was at the latter date.  The statistics, after over 3000 observations, were unconvincing.  For those of you who are statistically oriented, the regression analyses produced the following results:

Regression ResultsThe most interesting finding in the data is how little the VIX contributes to explaining where the market will be 20, 50, 100, 200 or 300 days hence.  The data say says, for example, that the VIX’s level on 3400+ trading days contributed only 0.14% to where the S&P 500 Index actually wound up 20 days later, a miniscule amount.

Interestingly, the contribution of the VIX increases to 5.12% in accounting for where the market ends up 300 trading days later, still a negligible amount.

Perhaps the accuracy of the VIX in predicting the market’s future direction is best transmitted in a picture (this one is really “worth a thousand words”);this one is shows the market’s percentage change 20-days after the VIX reading (click on image to enlarge):

VIX 20 day

As you can see that the S&P Index changes very little over the 20 days following the VIX reading regardless of whether the reading is below 20 or higher than 50.  Furthermore, the market is just as likely to increase over the next 20 days as it is to decline…..again regardless of the actual level of the VIX, be it 15 or 65.

The major difference between the above chart for 20 days and those for longer spans between the VIX reading and the change in closing value of the S&P 500 Index is that the dispersion around the average change is wider.  The longer the time that passes, the greater the opportunity for more dramatic market changes.  To see those charts, click on 50 days, 100 days, 200 days, 300 days.

So if you hear or read a talking head warning of dire consequences too much complacency, of a VIX reading that is “too low by historical standards”, then remember this statistical analysis showing that the market is as likely to increase as it is decrease at nearly all levels of VIX readings …. that VIX and future market trends are virtually independent.

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