For those who missed today’s market action and just looked at the post-mortem reports, today probably looked like just another in a series of uneventful days. For those who were paying attention to the likes of theVIX futuresand ETPs based on VIX futures such asTVIX(+10.7%) andVXX(+5.2%), however, the tension in the air was obvious.
But the SPX, DJIA and NASDAQ composite indices were all up today, so what’s the big deal? It turns out that investors are easily spooked if the VIX (+2.6%) and the SPX (+0.1%) both move in the same direction. As the graphic below shows, the VIX and the SPX move in the same direction about 22% of all trading days. I think the real issue behind the concern about the direction of the VIX and the SPX is related to a hypothesis I laid out yesterday inWhat the VIX Kitchen Sink Chart Says:
“…the general consensus seems to be that stocks just do not deserve their current lofty valuation. In this type of environment, many investors become particularly susceptible toconfirmation biasand scramble to find one or more indicators which will tell them what they have already begun to believe: that a major correction is likely just around the corner.”
The last time I crunched the numbers forVIX and SPX daily correlations, was in May 2007 and in looking at data from 1990, I concluded that aHigh Positive Correlation Between VIX and SPX Often Signals Market Weakness. Interestingly, when I ran the numbers today, the data from the last five years had completely reversed the conclusions. Thanks to some particularly strong results from 2009 and 2010, the full data set (1990-2012) now shows that when both the VIX and SPX are up on the same day, the mean returns for the next 1-100 trading days far exceed the typical returns for the full data set.
In terms of key takeaways, it now appears that stocks perform best following days when the SPX is up and the VIX is down (the ROI +1 column refers to the performance of the SPX one day hence) and worst on days when the SPX is down and the VIX is up. Interestingly, if one combines the up/down and down/up days, as I have done in the “split up/down” row, the aggregate data set of the SPX and VIX going in different directions looks almost exactly the same as the full data set in terms of future performance.
Getting back to the up/up phenomenon of today and yesterday, this bodes quite well for stocks going forward, based on historical data. By the same token, down/down days correspond to future performance that is, on average, well below the full data set.
Of course another key takeaway is that no matter what the data says today – for this study or any study – future events may overwhelm the current historical data and invalidate the generally accepted conclusions, even with a large sample size.
Now I will be the first to admit that stocks are overdue for a pullback, but just because the VIX and SPX both advanced on two consecutive days does not necessarily mean the planets are aligning for anAquarianselloff. If investors are looking for that market reversal silver bullet, the SPX-VIX correlation data are not going to make them happy.
[For the record, the data in the table below includes Fridays and Mondays, so it is possible thatcalendar reversionmay have had an impact on the results.]
Below is a larger than usual set of links for those who may be interested in digging into the history of some of the SPX-VIX correlation themes in this space.
One of the more interesting developments of 2012 has been to watch the diminution of the strident bearish narrative that has been focused largely on the collision course between a preponderance of debt and low or negative growth. The bullish beginning to 2012, however, has not prompted many in the way of converts to the bullish camp. Instead, there have been whispers of “…overbought…” that have turned into a soft murmur and are now verging on becoming a loud chorus. Suddenly the general consensus seems to be that stocks just do not deserve their current lofty valuation.
In this type of environment, many investors become particularly susceptible toconfirmation biasand scramble to find one or more indicators which will tell them what they have already begun to believe: that a major correction is likely just around the corner.
For better or for worse, a look at the VIX is often one of the first stops for those who are looking for evidence of a market reversal.
In the chart below, I have updated and extended a chart from three years ago that I call my “VIX kitchen sink chart” – as it pokes and prods the VIX in a number of different ways. Standard VIX analysis attempts to determine whether the VIX has strayed too far from historical norms, whether this be in the form of moving averages,Bollinger bandsor other mechanisms. I have even included a separaterate of changestudy (with its own Bollinger bands) and aBollinger band widthstudy below the main chart in order to provide a couple of additional analytical twists.
The bottom line, however, is this: if stocks are overbought and a correction is indeed just around the corner, the VIX does not appear to be aware of any such inevitability. Instead, it looks a lot more like business as usual in the land of the CBOE Volatility Index.