The VIX is Officially Overbought -- So What's Next?

The VIX has skyrocketed this week into overbought territory, but what that means for the future is far from certain

Jan 8, 2016 at 9:50 AM
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I know this will shock you, but the CBOE Volatility Index (VIX) has moved to "officially" overbought. And that's probably by any definition of overbought. I use greater than 20% above its 10-day simple moving average. It was about 34% above the trendline, as of Thursday's close, and now also greater than the CBOE 3-Month Volatility Index (VXV).

Generally speaking, it's a good contra tell, though results vary wildly. More on that soon. For now, I wanted to focus again on whether the fact that this is happening early in the year matters.

With one day to go, it's highly likely we will see the biggest percentage surge in VIX for the first week of a year. That's not surprising since Monday was the largest percentage pop for VIX on the first trading day of a year -- and we haven't exactly given up the vol ghost since then. Here's the first-week VIX performance going back to 1994:


160108agw1

It's not so simple to define "first week." If it's a clean calendar week like this year, it's easy. But in years when Jan. 2 is a Wednesday or Thursday, I went with one actual week. Yada yada yada, sometimes it's the first four days, sometimes it's the first five. Regardless, we're clearly off the charts this year.

The good news? It bodes relatively well for the rest of January. Here are January SPDR S&P 500 ETF Trust SPY returns (not counting Week 1) vs. first-week VIX action.


160108agw2

OK, not a lot there visually. But there's actually a 0.1127 correlation, so a very slight positive bias to the market. But when we look out to the end of the year, not so great:


160108agw3

If you squint, you'll see a negatively sloped best fit line in there. Specifically, there's a negative 0.1537 correlation. Again, not much, but this time it's negative. And we don't exactly need any negative biases these days.

It feels like we've had cartoonishly bad news to start the year. Nuclear bombsrising Middle East tensions between the two regional powers, Chinese currency and economic implosion. What's next?

I have no idea if China will right the ship any time soon. I'd suggest that these obsessions run their course and in a couple weeks we'll stop worrying about every Chinese market tick. But clearly, something else will hit our radar.

I'm not sure there's necessarily worse news flow now than at other times in the past. Rather, it's as if Mr. Market looks at everything everywhere and sees the bad in it. Until that mindset changes, it's going to be tough to shake this.

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

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