Current
Signal Performance as of
Signal
Type |
Trade
Date |
Return
since issued |
|
|
|
World |
U.S. |
|
Nasdaq
100
(QQQQ)
|
Russell
2000
(IWM)
|
S&P
500
(SPY)
|
|
The Nasdaq 100 (QQQQ) and S&P 500 (SPY) respectively gained 1.05% and 0.12% over the five-day span while the Russell 2000 (IWM) was basically unchanged. All three ETFs remain located above both their 50-day and 200-day exponential moving averages (EMAs).
For its part, our World portfolio posted a 1.02% loss this week. The portfolio consists of the 5 top-ranked world ETFs as of October 8, which marked the beginning of the current 4-week holding period.
Our current Buy signal remains in effect.
Our preferred volatility indicator is the Chicago Board
Options Exchange volatility index, also known as VIX, and as
you can see on Chart 1 below, it has been on a steady decline
over the last two years, with the exception of a quick rebound
in May of this year. Going by what is said and written in the
media and in the investment advisory community one might easily
jump to the conclusion that this volatility decline should coincide
with the end of the recent market rally. We do not know what
markets will do in the future but we do know, as we will endeavor
to demonstrate in this article, that a low volatility level
has never been a reliable indicator of market tops.
Chart 1: VIX and S&P 500 over the last 2 years
Volatility is a measure of changes in price expressed in percentage
terms, without regard to direction. It is frequently used as
a market risk indicator. Since future volatility (and the related
price changes) is only known when it has become historic volatility,
benchmarks have been created which use the prices of stock index
options as a way to estimate expected future volatility. Introduced
in 1993, the VIX has been considered by many to be the world's
premier barometer of investor sentiment and market volatility.
With a major facelift in 2003, by changing the way it is calculated
and switching to options on the S&P 500
instead of those on the S&P 100, and by offering the first-ever trading in VIX futures during
2004, VIX has become ever more popular.
The erroneous popular wisdom of equating low VIX readings with
a bearish sign stems from the following logic. High or rising
volatility corresponds to an increasing sense of risk which
culminates in the extreme fear typically seen at market bottoms,
and in perfect contrarian fashion a low or decreasing volatility
supposedly reveals investors being too complacent as is usually
the case at market tops.
As usual a picture is worth a thousand words, and to that effect
Chart 2 displays the VIX from 1990 to the present
day, overlaid on the S&P 500 Index as a reflection
of market price movements.
Chart 2: VIX and S&P 500 over the last 20 years
The first
deduction we can make from the chart is that absolute volatility
readings have no bearing on market trend. Markets have risen
during times of low volatility (e.g. 1995), as they have with
high VIX readings (e.g. 1999), and the same can be said of
declining markets. As one would expect, the higher the volatility,
the larger the distance between price highs and lows, which
is what volatility is all about. The best example of course
if the market crash of 2008 where the VIX reached an all time
high of 80.86, corresponding to a drop of 47% for the S&P
500. However, absolute reading of the volatility index does
not help spotting market tops. For instance, the top of the
internet bubble in March 2000 does not correspond to a volatility
bottom. The same is true of the market top preceding the subprime
debacle of 2008.
So instead of absolute VIX readings it must be relative VIX
values, or changes in volatility which show the way, right?
Wrong. What about the ratio of the index and the VIX (e.g.
S&P 500 divided by VIX) which some advisors claim to be the
magic formula? Nope. In fact, Mark Hulbert, the well respected
publisher of the Hulbert Financial Digest, has done extensive
analysis on this subject and concluded some time back that
there simply is no historical support for the notion that
a low VIX indicates that a market top is near, and that while
high VIX readings often have come before market rallies, the
same also appears to be true for low VIX readings.
What the chart above reveals however, is that large upward
VIX spikes consistently coincide with market lows as can be
seen repeatedly, including the one that resulted from the
September 11, 2001 terrorist attacks. A well known behavior
of markets is that declines are generally much more explosive
than increases. Markets can drop further over a shorter period
of time than they rise, as exemplified by the "Black Monday"
on October 19, 1987 when the Dow Jones Industrials
dropped by a whopping 22.6%. This primarily has to do with
human self-preservation psychology in which fear and panic
are much stronger emotions than enthusiasm and excitement.
Even during manias driving market bubbles skyward, volatility
does not come close to the spikes seen during bear market
declines and crashes. As a matter of fact, the chart reveals
that there are no downward volatility spikes.
As Trend Timers we have profited in times of both high and
low volatility. Significant bear markets and crashes coinciding
with volatility spikes where trend timing help us protect
our assets (going to Cash), or even profit from them using
Sell signals, resulting
in a much more satisfactory approach than the traditional
Buy and Hold approach. Just because we enjoy such periods
of extreme volatility does not mean we can use the VIX index
as a reliable market trend predictor. For that, we will continue
using the market itself and follow the trends it exhibits.
Question:
How do I update my personal information and preferences?
After you log in, go to the "My Profile"
page where your personal data and preferences reside. You can
update any of the information such as changing your password,
your credit card number or expiration date, or adding a new
e-mail address. Whenever you make changes or add information
make sure to save them by clicking the "Update"
button at the bottom of the page.
Please note that the "My Profile"
page also allows you to check your subscription status. To do
so, just click the corresponding button located at the top of
the page.
Warm wishes and until next week.
The TimingCube
Staff
|
| |
|