The VIX and What It All Means...
The VIX has been a bit of er.. vixen lately ;-). As a measure of investor risk-aversion, it has been, frankly speaking, all over the place this week. From 13.50 to 16 in 2 days?? Some of it of course is quite artificial, as we are after all in options expiry week, but one can't help but wonder what this yo-yoing all means.
The way I look at it, there are three distinct ranges of the VIX, as a measure of investor risk-aversion: "20 and above", "between 14 and 20", and "below 14", with 10 being sort of a natural lower limit (i.e. the market should possess some intrinsic volatility in it, caused most likely by trading activity itself). We spent the latter part of 2004 and a good part of 2005 in the 14 to 10 range, because, apparently market participants thought that the Greenspan put -- the one where the Fed is handing out loads of cash/liquidity to everyone and their brother to encourage them to speculate/trade/"invest" -- is going to last "forever". I am afraid to say that the Greenspan put is going away, not only because the Man himself is retiring soon, but because the reality of the macroeconomic climate we currently live in, dictates that the excess liquidity with which the Fed supported the market post-9/11 HAS to be removed, or the U.S. will suffer unbearable monetary and fiscal consequences (read inflation, credit crunch, savings shortfalls, massive indebtedness, etc.).
The "above 20" VIX range is probably reserved for "disasters of all sort", and a lot of those happened between 1997 and 2002 -- we had the Asian crisis, the Russian default, the LTCM debacle, the 9/11 scare, the Iraq war, etc. When you hit someone a lot of times with a bamboo stick on the shins, those shins will become used to the pain - in fact that's how Thai-kickboxers train. The market sort of got used to the pain during that period of time, and for this reason, it would be hard for the VIX, in the short run, to reach those lofty levels again so soon after 2002, even if similar "disasters" happen. The market has lived through those events too recently and its memory being so fresh, I doubt the reaction would be as drastic as if those things had happened for the first time. In other words, investors are afraid but not afraid enough -- i.e. experience counts.
Which leaves us with the last range - the one "between 14 and 20". This is the range that I think we are going to see in 2006. The VIX has slowly ticked up in the last 2 months, not least because investors know that the Fed is removing its accommodative monetary policy, high energy prices notwithstanding. In the last year, high oil prices have been offset by low yields, creating sort of a "lazy, goldilocks" economic scenario, which may have lulled a lot of investors to sleep, thinking that the economy is going to continue to grow without inflation, in spite of the pressure from energy prices. This is down to pure luck. This luck is about to run out in 2006. Credit spreads will gently widen, leverage, and hence volatility, will gently increase, the Fed will find a Greenspan successor who might not be as market-friendly as investors think, and America will have to face up to its fiscal and monetary excesses from years past. This is probably one of the reasons why the U.S. has been stuck in a rot this year, while pan-European and Japanese markets are seemingly booming. Global investors are concerned about the U.S. market's prospects, given all the headwinds that I mentioned above. The gradual increase of the VIX to its middle-range is just one more reflection of this global "avoid U.S. risky assets like the plague" phenomenon.
The way I look at it, there are three distinct ranges of the VIX, as a measure of investor risk-aversion: "20 and above", "between 14 and 20", and "below 14", with 10 being sort of a natural lower limit (i.e. the market should possess some intrinsic volatility in it, caused most likely by trading activity itself). We spent the latter part of 2004 and a good part of 2005 in the 14 to 10 range, because, apparently market participants thought that the Greenspan put -- the one where the Fed is handing out loads of cash/liquidity to everyone and their brother to encourage them to speculate/trade/"invest" -- is going to last "forever". I am afraid to say that the Greenspan put is going away, not only because the Man himself is retiring soon, but because the reality of the macroeconomic climate we currently live in, dictates that the excess liquidity with which the Fed supported the market post-9/11 HAS to be removed, or the U.S. will suffer unbearable monetary and fiscal consequences (read inflation, credit crunch, savings shortfalls, massive indebtedness, etc.).
The "above 20" VIX range is probably reserved for "disasters of all sort", and a lot of those happened between 1997 and 2002 -- we had the Asian crisis, the Russian default, the LTCM debacle, the 9/11 scare, the Iraq war, etc. When you hit someone a lot of times with a bamboo stick on the shins, those shins will become used to the pain - in fact that's how Thai-kickboxers train. The market sort of got used to the pain during that period of time, and for this reason, it would be hard for the VIX, in the short run, to reach those lofty levels again so soon after 2002, even if similar "disasters" happen. The market has lived through those events too recently and its memory being so fresh, I doubt the reaction would be as drastic as if those things had happened for the first time. In other words, investors are afraid but not afraid enough -- i.e. experience counts.
Which leaves us with the last range - the one "between 14 and 20". This is the range that I think we are going to see in 2006. The VIX has slowly ticked up in the last 2 months, not least because investors know that the Fed is removing its accommodative monetary policy, high energy prices notwithstanding. In the last year, high oil prices have been offset by low yields, creating sort of a "lazy, goldilocks" economic scenario, which may have lulled a lot of investors to sleep, thinking that the economy is going to continue to grow without inflation, in spite of the pressure from energy prices. This is down to pure luck. This luck is about to run out in 2006. Credit spreads will gently widen, leverage, and hence volatility, will gently increase, the Fed will find a Greenspan successor who might not be as market-friendly as investors think, and America will have to face up to its fiscal and monetary excesses from years past. This is probably one of the reasons why the U.S. has been stuck in a rot this year, while pan-European and Japanese markets are seemingly booming. Global investors are concerned about the U.S. market's prospects, given all the headwinds that I mentioned above. The gradual increase of the VIX to its middle-range is just one more reflection of this global "avoid U.S. risky assets like the plague" phenomenon.
posted by Ivan at 10/21/2005 10:48:00 AM
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