Did the VIX-plosion Turn the Market Complacent?

Volatility has fallen off noticeably after the CBOE Volatility Index's (VIX) recent explosion

by Adam Warner

Published on Jul 15, 2015 at 10:20 AM

Another day, another decline in volatility. "VIX & Fear Totally Collapse," says SlopeofHope.com. And if you look at his chart, it does give the impression of volatility literally jumping off a cliff. Of course, if you construct any chart to be twice as high as it is wide, and start counting at a number higher than zero, you run the risk of producing misleading imagery.

Suppose you took 20 people and charted their height, and say they ranged between 5' and 6'6". If you started the chart at about 4'10", the taller folk would look about 10 times taller than the shorter ones. Here's how the CBOE Volatility Index (VIX) over the last five weeks looks when the width of the chart is about three times the height.

warner15071522

That cliff looks a lot flatter ... but whatever. Numbers are numbers and VIX has seen an abrupt drop this week. It's down 30% or so in about four trading days. That's large, but it's not unprecedented.

It's certainly a sign of "complacency," or at least a sign of a speedy reduction in fear. I'll agree with the gist of the Slope of Hope header. The real question, though, is does it mean anything for the market?

So, with that in mind, I looked at the SPDR S&P 500 ETF Trust (SPY) since July 2009. Here's every instance where VIX declined 25% close-to-close over a one-week (five trading days) stretch, and the one-week, one-month, and three-month returns, if you bought on the first close where VIX had dropped greater than 25%. On the bottom, I include random one-week, one-month, and three-month returns.

150715VIXpop

We haven't quite hit the threshold yet this go-around, as it's not quite a week off the highs yet. And hey, maybe VIX explodes today or tomorrow and we don't hit it! Anyway, as you can see, there's absolutely no signal here in any time frame. The market has mostly gone higher after the VIX implosions, but it's mostly gone higher in the last six years over any random time frame.

And it kind of makes sense. For one thing, I've yet to conjure up a study that finds a tradable signal in complacency. It's just a lousy market driver. Fear is a strong emotion and tends to resolve itself in some fashion. It's generally bullish, but at times it's incredibly bearish. Crashes happen off fear spikes, they just don't happen all that often.

Apathy is a weak emotion. By definition, it calls us to inaction. It doesn't resolve quickly ... it doesn't really resolve at all, it's just there. Calling what we see right now apathy or complacency only serves to mislead, though. A better description is that we had a fear spike that played out over about two weeks, and now we've simply returned to our regularly scheduled programming. And this is a show that's been running for over six years now. And there's no indication that an abrupt return to the norms leads to anything unusual in the markets.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research


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