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What the VIX Really Tells Us


Debating the predictive prowess of the so-called fear gauge.


Question before the house: Can we use the VIX as a predictive measure for the market?

The Chicago Board Options Exchange Volatility Index, known as the VIX, or the "fear gauge," has been heading south.

The VIX closed at 16.91 on Wednesday, down 4.4%, hitting its lowest point in nearly two years. The Wall Street Journal notes that there hasn't been a close below 17 since the 16.47 close on May 16, 2008.

This might lead some to figure that investors are feeling a lot less jittery about the equity market.

Then again, if recent research on the subject is to be believed, maybe the much-hyped gauge actually tells us precious little.

This is what the research team at Birinyi Associates recently concluded, after studying the issue in-depth.

The analysts there note: "For those whose time and patience is limited, we will at the outset present our conclusion: the VIX is a coincidental indicator with limited predictive value. It details, perhaps better than other measures, the volatility of the market today but not tomorrow or the day after."

Birinyi generously passed their research to us for a quick review. CliffsNotes version: They find that low readings, generally considered bullish, are followed by mixed markets for the next 60 days.

Interestingly, they note, when readings are high -- which is generally considered a negative -- the market actually does better in the one-, two-, and three-month readings, but is lower six months out.

Okay, but what about violent spikes in the VIX?

Birinyi says that extreme readings -- both up and down -- are followed by a market which is higher 90 days later.

Bottom line: The VIX, so the analysts say, is a measure of current volatility with little or no predictive or indicative value regarding the course of the market.

For the record, it should also be noted that Birinyi continues to have very little patience for all you technical analysts and chartists in general.

They rattle off their gripes: a disappointing record of articulating market turns; an even more disappointing record of stock selection; and their tendency to comment rather than analyze.

Of course, the VIX still has its defenders.

David Penn of Trading Markets notes that traders use the VIX both to trade markets like the SPDR S&P 500 ETF (SPY), which includes holdings like Apple (AAPL), Exxon (XOM), and Microsoft (MSFT), as well as to trade the Volatility Index itself through instruments like the iPath S&P 500 VIX Short Term Futures ETN (VXX).

Penn writes:

Larry Connors [Connors Research] showed that when traders compare the VIX to itself over the short term -- for example, comparing the VIX to a 10-day moving average of the VIX -- this widely used indicator actually has a very good track record of helping short-term traders anticipate and trade market turns. The trick is to see the VIX as a very dynamic indicator, not a static one.

Gluskin Sheff's David Rosenberg, bear of all bears, also weighs in. He asks his readers to consider the following:

The VIX index slides from 42 on October 9, 2002 to sub-18 exactly five years later and the S&P 500 doubled; the VIX then surged to 50 by March of 2009 and the market was down 60%; the VIX then went on to plunge from 50 on March 9, 2009 to sub-18 on January 19 of this year and the stock market soared 70%. Since January 19, the VIX has been flat and so has the equity market.

To which Adam Warner, a proprietary option trader with Addormar, responds: So what?

Birinyi's whole point, he emphasizes, is that the VIX works as a coincidental indicator and Rosenberg doesn't disprove that thesis.

"So what if the market was down and the VIX was up?" says Warner. "The VIX moved because the market moved."

From his perch, Warner thinks Birinyi is spot on: "The VIX does a much better job at telling you what happened then predicting what will happen."

So, what is the VIX telling us now then? Only that activity in the stock market remains unusually calm.

"The VIX is just a proxy for the volatility of a 30-day option in the S&P 500," he says. "So, it is just saying volatility is low. In fact, volatility is getting crushed right now."

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