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July 13, 2005 |
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The VIX – which measures S&P 500 options activity and has historically been an accurate indicator of extremes in investor fear and complacency – has also trended lower since Iraq operations began. In fact, the VIX has trended so low and without any major break higher since early 2003 that many have speculated that its value as a market indicator has been lost.
Similarly, the CBOE’s put/call ratio – also considered to be an indicator of market extremes – has become an increasingly less important market indicator. It used to be that when the P/C ratio shot above 1 that all heck was breaking, or would soon break loose in the markets. While this theory held true for most of the 2000-2002 bear market, it has sent out countless false signals ever since.
Cracks aplenty, But Bears Can’t Catch A Break The downgrade of GM & Ford debt earlier this year was followed by widening credit spreads and rumors of an imminent hedge fund collapse. Oil has been trading near record highs for most of the year, with $62.10 a barrel marking the recent high (July 7). The US and global economy has shown signs of slowing down, the Fed continues to raise short term interest rates, the yield curve continues to flatten, and corporate earnings growth is threatening to slow down... Surprisingly, amidst all of this uncertainty volatility has not returned to equities. Rather, the VIX remains near all-time lows, and the last time the DJIA tested 10,000 (on April 20, 2005), the index was held inside of a 2.5% trading range. Quite frankly, that 2.5% is the largest daily trading for the Dow in 2005 is somewhat bewildering. After all, 2.5% is below the average daily trading range since 1999; below the average DTR during the great bull market and below the average DTR during the bear market. The argument could be made that hedge funds, flush with cash and short on investment ideas, are shorting market volatility. Another simplistic argument is that new naive investors have found their way into the options market and are increasing chasing put option strategies as the so called ‘smart money’ writes the options (thus explaining why the P/C ratio has lost its value as an indicator). Speculations aside, the only conclusion to be made is that the decline in volatility since March 24, 2003 has been unusual, and only when volatility returns to the marketplace will bears have something to cheer about. BWillett@fallstreet.com |
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March 24, 2003. This day is significant not only because it was the day when US troops marched to within 60-miles of Baghdad, but also because it is, arguably, the last day of US stock market volatility. To be sure, on March 24, 2003 the Dow Jones Industrial Average traded as high as 8514.82 and as low as 8166.78 before settling at 8214.68 (or a 4.2% trading range). Since this day the DJIA has never traded outside of a 4% trading range (for that matter, since May 27, 2003 the Dow has never traded above a 3% daily trading range). 
