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Study of the Week: What Do a 'Low VIX Is Bearish' Argument and Manti Te'o's Girlfriend Have in Common?


To get the facts, take a longer-term look at the VIX and you'll see that it spent multiple years beneath 20 in each of the past two decades.

Unless you live under a rock, you've heard about Manti Te'o's fictional girlfriend. Although there is a lot more to this story that we don't know, one thing is for sure: She never existed and it fooled a lot of people. What does this have to do with the VIX, you ask? Well, for whatever reason, we continue to hear how a "low VIX" is somehow bearish for the SPX. Turns out this is just another myth. I'll take the reins from Deadspin and report on this one now.

How many times have we heard that a VIX of 15 is bearish over the past year? Or how many arguments have been made that a VIX under 20 isn't sustainable? As Bernie Schaeffer recently noted, the biggest market disaster of '12 wasn't the Facebook (NASDAQ:FB) IPO or the underperformance of bonds versus stocks; it was the huge drop in volatility in the face of huge bets on higher volatility.

Take a longer-term look at the VIX. You'll see that it spent multiple years beneath 20 in each of the past two decades! In other words, volatility can stay low for a very long time and this is completely normal.

Back in July I did a Yahoo Breakout spot with Matt Nesto, laying out the reasons why we could expect the VIX to stay low. It was trading at 20 when the video posted and yesterday closed around 13. At the time, this wasn't a very embraced call, but the main reasoning was everyone was looking for higher volatility. Sure enough, once again the crowded trade didn't work. Fast forward six months and I still feel we could be looking at potentially another year or two of a VIX consistently beneath 20 – just like we saw in the '90s and '00s.

Lastly, here's a study that hammers home the fact that a VIX beneath 15 isn't bearish. Going back to '90, the SPX does better a month later when the VIX closes beneath 15 than when it closes above this 15 (0.75% vs. 0.59%). Starting the same study in '00 shows even more of a discrepancy, as the SPX returns 0.50% a month later versus 0.05%!

In conclusion, there are a lot of myths out there that fool us. Don't let the "low VIX is bearish" one be another.

This article by Ryan Detrick, CMT, was originally published on Schaeffer's Investment Research.

Below, find some more great content from Schaeffer's Investment Research:

Daily Game Plan – Markets Breaking Out

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Chart of the Day: Molycorp, Inc. (MCP)

Twitter: @schaeffers
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