What’s Next for the VIX and the S&P 500…Objectively Speaking

“The only thing we have to fear is fear itself.” – Franklin D. Roosevelt

The VIX, which is a measure of the market’s expectation of 30 day volatility using S&P 500 index options, is commonly referred to as a “fear gauge” for investors and the market.

The VIX ended Friday at about 21.24, its highest level since the beginning of February. It’s up a whopping 75% in the last three weeks alone. So, by the most common measure, it seems fair to say that fear has re-entered the markets in full force.

Over the same three weeks, the S&P 500 is down -3.6% and most of that drop (-3.2%) has come in just the last two days. Our markets, and world markets, are jittery.

In our weekly market call we often talk about the impact of human nature on the markets. We are predisposed to think that recent good times will last indefinitely, and then with the market down over 3% in two days, fear, panic and overreaction do set in for a portion of the market which can precipitate the sell off. Is this the start of a massive correction or just a short term pull back?

In instances like this, whether you’re looking at extreme moves in a security or in the broader market, having an objective gauge for the typical outcomes is valuable. EidoSearch provides this accurately in seconds with transparency, and we take it a step further providing probabilities based on the historical instances.

Here’s a recent example of the benefits of having an objective gauge for how the markets typically react to similar circumstances in the market. The images could be better, but in our market call from two weeks ago (The Knowledge – What’s Next for Janus) we did a study on the 43% jump in Janus’ stock price (JNS) after the news of Bill Gross joining the firm. Per the projection below on the left, we showed what typically happens next based on similar instances historically (Red line). The chart to the right is what has happened since over the past couple of weeks.

We don’t normally expect to nail it like this of course.  It’s more about quantifying the range of likely outcomes.  In the projection chart from two weeks ago you can see that there was little projected upside, whereas there’s six times the downside.  We provide an objective input to answer questions like, “Do I lock in some gains here?” or “Is this a good time to short if I still dislike the fundamentals?”.

You don’t need to be a believer in technicals, price trends or behavioral analysis.  This is simply statistics, using the range of outcomes historically (actual return distributions) to generate a range of forward outcomes that we have validated to have predictive nature.

In follow up to a piece we did 3 months ago looking at longer term price trends in the S&P 500 from 1 year to 5 years in length, we thought it would be interesting to look at a shorter term, 1 week forward projection for the S&P 500 and VIX to have a gauge for what’s likely to happen this week.  Clients can run this in our software in about 20 seconds.

Current 1 month price trend:  Out of 99 statistically similar historical instances dating back to 1980, the S&P 500 is up 71% of the time an average of .9% in the next 5 days.  Only two instances are down worse than 5% over the next week over the past 35 years, and both happened in October of 2008.

Current 1 month price trend in the VIX:  Out of 37 statistically similar historical instances dating back to 2004, the VIX is down 73% of the time and the average is -8.4% in the next week.  The only two instances that continued up more than 10% in the next week were November of 2007 and July of 2011.

Have a great week!