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The shockingly subdued ‘fear index’ doesn’t mean what you think it means
By Mark Hulbert | July 18, 2017

The VIX is one more thing Mark Hulbert says not to worry about



CHAPEL HILL, N.C.—Here’s something else not to worry about: The record low VIX level hit last week.

The list of such things to ignore is already quite lengthy, and in recent weeks I’ve added yet more things to it. Just last week I argued that the flattening yield curve is not the cause of concern that many are assuming it is. The week before that, I argued that analogies to the top of the internet bubble aren’t based on fact.

This week I’m adding the low VIX VIX, +1.53% because many—erroneously—interpret it in a contrarian fashion. To be sure, if that interpretation were correct it would indeed be worrisome that the VIX last week plunged to its lowest close since December 1993. However, the contrarians are wrong.

But, first, I want to stress that I’m not a Pollyanna who blithely dismisses any concerns about the stock market. There are plenty of things to legitimately worry about right now, not the least of which is an extremely overvalued market.

But it’s noteworthy when so many investors are fretting about things that have little or no objective basis. In fact, it’s actually bullish when so many investors are eager to worry about bogus issues.

The reason a low VIX reading is not, in and of itself, something to worry about: The stock market on average has performed better subsequent to lower readings than higher ones—as is well illustrated in the accompanying chart.

This isn’t to say that you can’t tell a superficially plausible story that reaches the opposite conclusion. For example, the stock market in the past has turned in well-above-average performance following the VIX’s extremely high readings. But there’s a statistical sleight of hand involved in such stories.

That’s because we can only know after the fact how high the VIX will soar. Before the 2008 financial crisis, for example, the VIX had never risen above the 40s. It reached that level again in September 2008, on its way to eventually reaching almost 90 in November, before falling back to its pre-2008 record in December of that year. The S&P 500 lost 20% over this three month period.

It was in a column nearly one year ago that I challenged the conventional, contrarian, interpretation of the VIX. The occasion of that column was the VIX dropping to a very low 11.33, one of the 5% lowest readings in history. The S&P 500 SPX, -0.01% is more than 14% higher today, if you take dividends into account.

This happy result is not an accident. Over the last three decades, the way to have made money from the VIX was to interpret it opposite to how a contrarian would—to be a contrarian’s contrarian, if you will. That at least is the conclusion of an academic study that is forthcoming in the prestigious Journal of Finance and written by two Yale finance professors, Alan Moreira and Tyler Muir. If the future is like the past, they convincingly show, you can safely invest in equities so long as the VIX remains low. You would reduce your equity exposure only when volatility spikes.

This isn’t a guarantee, I hasten to add. Making money is never assured.

But you are guaranteed to lag the market over time if you trade according to premonitions and hunches that have no basis in fact.

http://www.marketwatch.com/story/the-shockingly-subdued-vix-doesnt-mean-what-you-think-it-means-2017-07-18

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