VIX: Fear Is on the Wane

Lately it seems like I'm the only one who's not talking about the VIX. I find it particularly ironic that many of the same people who were pounding the table, saying that the market couldn't bottom unless there was another dramatic VIX spike and high-volume capitulation, are now insisting that the markets cannot rally from current levels until the VIX continues down. I suspect these pundits will end up going 0 for 2 in their predictions.

For the record, at the very moment the SPX formed the “devil’s bottom” of 666.79 on March 6, the VIX was at 51.65 - which wasn't even the high for the particular day. By the end of the day, the VIX was down to 49.33 in what looks, in retrospect, like a classic stealth bottom.

So what's driving the VIX right now? In a previous post, Tricks of the VIX,  I opined that a simplistic conceptual model of the VIX is one which “incorporates incremental changes in uncertainty and fear on top of recent historical volatility.” Many of the common measures of historical volatility (10-, 20-, 30- and 50-day) show that historical volatility in the SPX topped in the middle to latter portion of March.

Since the 7.08% jump in the SPX on March 23, trading has been relatively subdued from a volatility perspective. As that 7.08% jump, as well as the 6.37% and 4.07% jumps from March 10 and March 12, begin to scroll off the lookback window, historical volatility numbers should begin to lead the VIX back down.

As far as fear and uncertainty are concerned, the fear of a global systemic bank failure seems to be receding, while concerns about a deepening global recession are lingering and still rising in some quarters. The G20 meeting underscored the willingness of leaders of the world’s largest economies to coordinate their activities, even if they cannot agree on the details of those coordinated efforts.

Finally, we're in a news-cycle lull this week, but earnings season officially kicks off with Alcoa (AA) reporting tomorrow.

The bottom line is that current levels of the VIX are in line with historical volatility readings and changes in the macroeconomic landscape. The fear component of the VIX is clearly on the wane, which should mute any VIX spikes. On the other hand, historical volatility needs to continue to decline, and the VIX term structure (which is based on SPX options) and VIX futures need to soften somewhat before the VIX can reasonably be expected to start trading in the 30s on a regular basis.

Many analysts have a tendency to rely too heavily on charts when looking at the future of the VIX. While charts can provide some useful information -- and it's nice to know that the VIX has recently moved below its 200-day moving average -- sometimes putting the VIX in the proper geopolitical and macroeconomic context is a more valuable approach.

So, I think the VIX is about where it should be right now, and stocks can resume their move up without the VIX being required to plummet. In fact, if the bulls continue to keep the upper hand, expect the VIX to decline in a decidedly gradual fashion.

Finally, the VIX jumped 3.1% today, while the SPX lost 0.83%. That -4x move is typical of the VIX, but not on Mondays, when "calendar reversion" usually means the VIX jumps about 1.5%. Add to this the 1.53% that the VIX fell in the 4:00 p.m. - 4:15 p.m. ET index trading portion of Friday’s session and one could make the argument that the VIX barely moved at all today, relative to the SPX.