VIX Index Looking at Next Top
City Index May 25, 2013 12:30 AM
<p>As the Nikkei loses 7% in a single session and the FTSE-100 posts its first 2.1% daily decline in exactly one year, questions abound about […]</p>
As the Nikkei loses 7% in a single session and the FTSE-100 posts its first 2.1% daily decline in exactly one year, questions abound about what has gone too far too fast. We mentioned last week that the FTSE-100 has gone 51 weeks without a peak-to-trough decline greater than 10%. The S&P50 has gone 50 weeks. This is close to the 53 and 56 weeks that each index has rallied without more a loss of more than 10%. Does this mean that the next meaningful sell-off will take place later this month? Declines are inevitable. It is the magnitude, which matters.
Looking at the VIX – an index long frowned upon by bulls and bears alike after posting many a false signals-it’s worth examining the periodicity of its recent tops. The chart below illustrates the last four meaningful peaks in the VIX occurred at 2-month intervals, starting in October. Nonetheless, each of those 4 rallies in the VIX corresponded to a decline of 3.4%-3.8% in the S&P500 in each. The sell-off may be modest, but considering the 10% over the last 5 weeks, the likelihood of a summer sell-off is solid.
It’s no secret that FOMC members are looking at reducing asset purchases later this year, with some members preferring to start tapering in the summer.
Yet the Fed Chairman clearly indicated the condition for tapering is “evidence of sufficiently strong and sustained growth”. The point of contention then becomes over what constitutes “strong and sustained growth”. Private economists are starting to issue their own formulas; such as 2 consecutive job reports of +200K in NFP and no monthly gains in unemployment by more than 0.1%.
As Bernanke warned, and supported by at least 3 FOMC members, “withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions”. Therefore, it is safe to agree that as markets are likely to prolong their (temporary) selloff in June, neither the economy nor the markets would be fit for “strong and sustained growth” thereby, not qualifying for any reduction in rates.
Regardless of whether less than a 1/3 of voting FOMC members favour tapering, all that is needed is to make their pronouncements to the media. This would force a required pullback in markets. And when tapering asset purchases becomes closer to reality (Q4 at the earliest), determining the new lesser amount of purchases will be the next phase shaping expectations and market direction.