With The VIX Over 20, Bulls & Bears Alike Are Licking Their Chops

July 26, 2007 by Douglas A. McIntyre

Late morning DJIA -230, S&P 500 -27, NASDAQ -44, 10-Year Treasury down almost 9 basis points at 4.815%….. Flight to quality….. M&A ending….. Tax Changes….. Weak Dollar….. Junk Bonds….. Credit Crunching….. Weak Housing….. Weak Consumer….. Financials and Transports Selling….. Widening of credit risk….. Higher Energy Prices….. call today’s drop whatever you want.  You never know what the last dollar is and you can’t ever hold out that the last dollar has been seen.  But there is an interesting datapoint that many technicians use: the CBOE Volatility Index, the good old "VIX." 

We’ll use lay terms here only, so you can go to Investopedia for a full explanation summary if you choose.  As the VIX rises it represents a higher premium that investors are willing to pay for protection.  As the VIX falls it means that Main Street is not too worried about Wall Street and the public is less concerned about a market drop.  When you get extreme readings, that is usually used by technical traders to mark either a bottom or at least a level for an entry point.  The definition of "extreme" will vary wildly and everyone has to decide what their version of extreme is.

The quasi norm of late has been a very low VIX reading.  It even went well under 13 and challenged a 10 reading for much of early Q1-2007, meaning on a collective basis no one was all that concerned about a market drop.  In February the market experienced a mini-meltdown, and at one point the VIX challenged the 20 level with a high reading of 19.01 in February and high of 21.25 in March.  The highs in the May 2006 to July 2006 a year ago had the VIX at highs of 19 to 23.28 before the markets went into rally-mode.  Go back to early 2003 and 2002 and the VIX was steadily trading in the 30’s and the 40’s when the recession was peaking there were still concerns galore.  At the peak of the September 2001 selling the VIX reached as high as 43.74.

We noted the VIX when it was under 10.0 briefly and even noted an investor’s Nirvana existing before the last mini-meltdown.  Guess where the VIX is today.  The current reading has just crossed over the 21.0 handle, and was as high as 19.46 yesterday and 19.09 on Tuesday.  These are not historically any major numbers, but in what was feeling like a new low-VIX world this is at least getting close to what would seem to be an extreme reading.  Does that mean the VIX can’t continue climbing and that the stock market can’t see added selling?  Absolutely not.  Can we see a 30 reading or higher on the VIX?  We’ve already shown you when and where that happened.  On last look only 6 of the 30 DJIA components were  in positive territory.

As the DJIA and S&P 500 Indexes fall, that VIX will rise; and vice versa.  The DJIA is already more than 500 points off of its new recent highs of 14,121.00.  We won’t tell you whether you should be bullish or bearish on the market as a whole.  It would seem that if this was a true bear market starting, then it would be really hard to find winners out there.  Right now that isn’t the case.  That can change.  The bears are probably finally happy that their short sales at record levels are finally more in their favor.  But the bulls are looking for their picks, and this is a prime example of why traders like keeping cash in reserves for buying opportunities. 

It is always prudent to tread carefully, because you never know how bad things can get.  Markets always go up too much when they get into bull mode, and they always trade down too much in a panic.  You might or might not like George Soros, but this proves over and over his theory: "Contrary to the tenets of market fundamentalism, financial markets do not tend toward equilibrium; they are crisis prone."

Jon C. Ogg
July 26, 2007

Jon Ogg can be reached at jonogg@247wallst.com; he does not own securities in the companies he covers.