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Over the
past 5 months we have seen volatility steadily decline as stocks and
commodities rise in value. The 65% drop in the volatility index is now
trading at a level which has triggered many selloffs in the stock market over
the years as investors become more and more comfortable and greedy with
rising stock prices.
Looking at the market from a HERD
mentality and seeing everyone run to buy more stocks for their portfolio has
me on edge. We could see a strong wave of fear/selling hit the S&P 500
Index over the next two weeks catching the masses with their hand in the
cookie jar . . . again.
If you don't know what the volatility
index (VIX) is, then think of it as the fear index. It tells us how
fearful/uncertain investors are or how complacent they are with rising stock
prices. Additionally a rising VIX also demonstrates how certain the herd is
that higher prices should continue.
The chart below shows this fear index
on top with the SP500 index below and the correlation between the two
underlying assets. Just remember the phrase "When the VIX is low
it's time to GO, When the VIX is high it's time to BUY."
Additionally the Volatility Index
prices in fear for the next 30 days so do not be looking at this for big
picture analysis. Fear happens very quickly and turns on a dime so it should
only be used for short term trading, generally 3-15 days.
Volatility Index and SP500 Correlation & Forecast Daily Chart:
Global Issues Continue To Grow But What Will Spark Global Fear?
Everyone has to admit the stock
market has been on fire since the October lows of last year with the S&P
500 Index trading up over 26%. It has been a great run, but is it about to
end? Where should investors focus on putting their money? Dividend stocks,
bonds, gold, or just sit in cash for the time being??
I may be able to help you figure that
out.
Below is a chart of the Volatility
index and the gold exchange traded fund which tracks the price of gold
bullion. Notice how when fear is just starting to ramp up gold tends to be a
neutral or a little weak but not long after investors start selling their
shares of securities we see money flow into the shiny yellow safe haven.
Gold & Fear Go Hand-In-Hand: Daily Chart
Looking at the relationship between
investor fear/uncertainty and gold you will notice scared money has a
tendency to move out of stocks and into safe havens.
Trading Conclusion Looking Forward 3 months...
In short, I feel the financial
markets overall (stocks, commodities, and currencies) are going to start
seeing a rise in volatility meaning larger daily swings which inherently
increased overall downside risk to portfolios and all open positions.
To give you a really basic example of
how risk increases, look at the daily potential risk the SP500 can have
during different VIX price levels:
Volatility index
under 20.00 Low Risk: Expect up to 1% price gaps at 9:30am ET, and up to 5%
corrections from a previous high.
Volatility index between 20 - 30 Medium Risk: Expect up to 2%
price gaps at 9:30am ET, and up to 15% corrections from recent market tops or
bottoms.
Volatility index
over 30 High Risk: Expect 3+% price gaps at 9:30am ET, and possibly
another 5-15% correction from the previous VIX reading at Medium Risk
Note on price
gaps: If you don't know what I am talking about a price gap is simply the
difference between the previous day's close at 4:00pm ET and the opening
price at 9:30am ET.
To continue on my market outlook, I
feel the stock market will trade sideways or possibly grind higher for the
next 1-2 weeks, during this time volatility should trade flat or slightly
higher because it is already trading at a historically low level. It is just
a matter of time before some bad news hits the market or sellers start to
apply pressure and either of these will send the fear index higher.
Chris Vermeulen
Editor, the
Gold and Oil Guy
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