Is a Calm VIX Good News or Bad News?

VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. A high value corresponds to a more volatile market. It is often referred to as the fear index. It represents one measure of the market's expectation of volatility over the next 30 day period.

A common interpretation of the VIX's value is that if it is above 30 or so, market participants are displaying fear of the market, and a market drop is likely in the making. Investors believe that a high value of VIX translates into a greater degree of market uncertainty, while a low value of VIX is consistent with greater stability. But another interpretation is that a low reading indicates complacency, low interest in the market, and therefore that the market might be ready for a fall, because there is little conviction on investors' parts.

Earlier today, I read the following from a well-respected analyst/pundit concerning the VIX: "The CBOE Volatility Index (VIX) fell to a low of 16.17 on Friday. The last time we saw a number on the VIX that low was in May of 2008, just prior to the fall from 13,000-plus to 10,970."

The implication was that the market is complacent, rolling over, and in his words, it’s time to “raise cash [sell stocks in anticipation of a decline] and be defensive.”

Is that quoted statement accurate? Yes. Is it misleading? Also yes.

It is true that the last time the VIX was at current levels was in 2008, just before the steepest part of the market crash that had begun in October, 2007. However, if you widen out the VIX chart to a 10-year look, you see a totally different pattern from the one implied by the statement above.

When the VIX hit 16 in 2008, it was rising, with increasing volatility. That presaged the market fall that the analyst referred to. But that moment in time had been preceded by a 3½-year period in which the VIX spent practically its entire time in the 10-20 range with low volatility. That period—from late 2003 to early 2007—coincided with a steady uptrend in the market. The Dow rose from about 9600 to about 13,000—about 35%--during that timeframe.

Currently, the VIX is falling, with decreasing volatility. It has dropped from a high of about 80 at the beginning of 2009 to its current level of about 16. The correct comparison is not between the VIX’s current level of 16 to the last time it was 16. The correct comparison is to the last time the VIX looked something like it does now. That would be mid-2002 to mid-2003, the last time the VIX was descending, with decreasing volatility, from a multi-year high to a level of 20 or below. The post-dot-com bear market, of course, ended in October, 2002, ushering in 5 years of a rising market that did not peak until October, 2007.

Disraeli said, “There are lies, damned lies, and statistics,” a saying that was popularized in the United States by Mark Twain. The statistic quoted at the beginning of this piece is the sort of thing they were talking about.