The Unimportance of a Sub-20 VIX

A subscriber sent me a link to a VIX study entitled "When the VIX Drops Below
20 Jump In" - you can see it here - and I wanted to comment on the study
because it highlights what I believe to be misleading information. As the
title suggests, the author is implying that a sub-20 VIX signals a 'green
light' for the market, and to prove the point they list a table showing
average positive returns for the Dow anywhere from one week to one year later
based on daily data since 1986. The problem with this type of analysis is that
it's very misleading. By going back so far in history and apparently counting
every occurrence of a drop from over 20 to under, It may be true that the
average three-month return for the Dow was +2%, but that's because stock
prices have generally risen over the last 20+ years. And as we'll see, this
concept of a sub-20 VIX having positive implications is only true when we're
in a steady bull market. When the tape turns sideways-to-down, following such
a strategy has produced horrendous results. Take a look at each instance since
2000 in which the VIX crossed from above 20 to below 20, along with the
performance of the S&P three months later...

VIX Crosses Below 20
12/21/07... SPX -10.4% three months later
10/31/07... SPX -12.1% three months later
10/26/07... SPX -11.9% three months later
10/17/07... SPX -8.1% three months later
09/21/07... SPX -5.2% three months later
06/15/06... SPX +3.5% three months later
03/24/04... SPX +3.6% three months later
03/17/04... SPX +0.1% three months later
03/12/04... SPX +1.9% three months later
10/03/03... SPX +7.8% three months later
09/11/03... SPX +4.4% three months later
08/08/03... SPX +8.3% three months later
07/18/03... SPX +5.2% three months later
07/08/03... SPX +1.0% three months later
06/26/03... SPX +3.8% three months later
06/18/03... SPX +0.9% three months later
05/30/03... SPX +3.1% three months later
05/22/03... SPX +7.3% three months later
05/09/03... SPX +3.4% three months later
05/31/02... SPX -11.2% three months later
05/22/02... SPX -14.5% three months later
05/14/02... SPX -17.5% three months later
04/12/02... SPX -14.2% three months later
04/04/02... SPX -12.1% three months later
03/08/02... SPX -10.6% three months later
03/06/02... SPX -8.2% three months later
03/01/02... SPX -5.1% three months later
08/24/01... SPX -2.3% three months later
08/03/01... SPX -10.5% three months later
06/29/01... SPX -15.2% three months later
06/21/01... SPX -21.9% three months later
06/07/01... SPX -11.2% three months later
06/05/01... SPX -10.5% three months later
09/28/00... SPX -10.5% three months later
09/19/00... SPX -6.8% three months later
09/07/00... SPX -12.5% three months later
07/14/00... SPX -7.2% three months later
07/07/00... SPX -2.9% three months later
06/29/00... SPX -0.2% three months later
03/03/00... SPX +0.9% three months later
01/14/00... SPX +2.4% three months later

Out of the last 41 occurrences since 2000, only 16 led to a higher S&P three
months later. And when it was wrong, it was really wrong, as was the case
repeatedly in 2001-2002 and again in 2007. I don't really know if the average
return for the S&P since 1986 was +2% as the study indicated, because it
doesn't really matter. The table above clearly shows a sub-20 VIX has no real
predictive power whatsoever. It does well when stock prices are generally
rising, but performs poorly when stock prices decline. That's a clear sign of
a setup that has no real edge, and is not something you want to rely on.

New 52-week highs on the NYSE declined again Thursday despite the S&P pushing
to a fresh three-month high in intraday trading. This continues to suggest
most stocks haven't been participating in this recent push, a short-term
negative sign.

Also noteworthy is the Nasdaq/NYSE Volume Ratio, which closed at a high 1.58
Thursday and continues to imply limited upside potential (see Wednesday's
column for details). This takes on greater significance in light of today's
rally, as it suggests the gains are most likely unsustainable over the short-
term.

Categories : Archived EOD Commentary, End-of-Day Commentary

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