Wednesday, March 17, 2010

Steady as she goes

A quick follow up on the Predictive VIX post:

I couldn't help noticing that on Monday, Tuesday, and Wednesday of last week that the VIX increased marginally (less than the 5% level that was examined in the original post) while the SPY also had marginally positive moves from close to close. So, since I have the data, I thought I might take a look at the occurrence of multi-day positive VIX and positive SPY over the March 1995 to present range.

Generally speaking, it proved to result in positive returns over the next 120 day period (there was no look back condition). On average, the SPY was approximately 4.2% higher 120 days from the event. However, results on a shorter 60 day forward looking period were much more mixed yielding an average return of 1.1% with a number of 1-3% down periods. In essence, there is the suggestion of a range bound market over the next 6 months.

So although the VIX is trading near pre-crash lows there is certainly the potential for it to continue lower since recent realized volatility in the SPY is considerably lower than the expectations reflected in the VIX. This would be consistent with a range bound market over the next 6 months. Additionally, as of last week, the market is still pricing in expectations of increasing volatility during 2010 (see Implied Volatility - Part 1), allowing the market a "wall of worry" on which to climb.

It should be noted that there were 3 multiple up/up events that produced significantly negative returns over 120 day periods: 1) late August 2000, while the in the throes of pricing in a bursting internet bubble, producing a -16% return, 2)December 2007, as the market began falling from its peak, yielded a -10% return, and 3) May 2008, when the crisis was really beginning to take its toll, resulting in a -36% return. Those were clearly unusual periods and current market conditions do not really resemble those times. Basically, it seems likely that the broad market is likely to find itself up or down 3-5% over the next 6 months with decreasing volatility. That is hard for me to say because I personally believe that there are a number of factors that could negatively impact world markets during 2010, but the numbers suggest that if there is an impending disaster on the horizon, it may take some time to surface.


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