VIX: Calm Before a Storm?

A Vixen in the Wild

A Vixen in the Woods

After predicted volatility, early this year, the VIX (SP500 Volatility Index) has settled down to a low not seen since late last year. It fell below 12 within the past trading session, and settled a little above 12 at the close. The chart below gives an indication of this measure of calm in the fear index.

The Fear Index, VIX, year-to-date

The Fear Index, VIX, year-to-date

But does VIX truly reflect market conditions at present? According to Rebecca Cheong, head of equity derivatives strategy at UBS securities, the VIX is unusually low compared with similar readings of expected price swings in other assets and asset classes. Cheong is quoted as saying that VIX doesn’t stay low relative to all other assets for long, and that a tumble in stocks may lie ahead. She cites examples from 2013, in August 2013 and December 2014, when the S&P500 fell significantly, as much as 5%, in the month following.

There are other indications that all may not be well for the market ahead. June is said to be the worst performing month over the past decade. The popular saying: “Sell in May and go away” has not been realized this year; despite assurances of an interest rate hike, from the chair of the FED, later this year upon confirmation of an improving economy, the market has continued grinding upward. Weak GDP numbers, a strong dollar, and weak consumer sentiment continue to weight upon the markets.

But what is rather curious is a clear divergence between the Dow Jones Transportation (DJT) index from the Dow Jones Industrial Average (DJI), in the past few months, as seen in the chart below:

Dow Jones Industrials and Transportation divergence

Dow Jones Industrials and Transportation divergence

While DJI and DJT are seen to have tracked each other very well in the first quarter, as is normal, they have diverged significantly in the second. Whereas the industrials have continued to rise by around 2%, the transportation average, reflecting the movement of goods within the economy, has sunk by more than 6%. While this divergence appears to coincide with a turnaround in the fall of OIL prices, around the middle of March, significantly lower absolute oil prices this year must surely be beneficial to the transportation sector? Despite oil price stability from early May, the DJT is seen to continue its negative trend, diverging from the industrial average, falling as much as 2% mid last week.

Such unusual conditions notwithstanding, some argue that the market is poised to break out. They refer to every signal in recent months, that indicated the beginning of a correction, reversed strongly with buyers rushing in upon a market pull back. Perhaps this also explains the low VIX, a certain absence of fear in the markets.

I am not of that opinion. I think that the present low VIX reflects complacency, a certain stupor induced by a pussyfooting FED that says and does little, and is likely a calm before an upcoming storm in the markets. Accordingly, I remain long VIX.

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About Rian Nejar

Rian Nejar is an Indian-American author. He trained and worked as an engineer in India, lived briefly in the Middle East, and arrived in America in the early 90's. After a Master’s degree in electrical engineering in America, he worked as an academic instructor, engineer, entrepreneur, and technical writer over the two decades since. Humbling and Humility is the first heartfelt written expression of his varied life experiences. He lives and writes in the Southwest United States.
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