Wednesday, November 21, 2012

Warnings From The VIX

The VIX is an index that measures market volatility. That is what most people believe, anyway. Actually, the VIX is an index that reflects the expense of put options on the S&P 500 index. And to further define, a ‘market’ of stocks no longer exists since the central bankers decided to set prices years ago by constantly manipulating the indices. Put options, of course, become more valuable when the S&P 500 index is falling. Therefore, a rising VIX generally reflects a falling S&P 500 and a falling VIX generally reflects a rising S&P 500. This would seem intuitive but the real question is does the VIX tell us anything about the future? Or, does it simply reflect a trading trend that we already observe?

The chart below is a 20-year look at the VIX in red and the S&P 500 in blue on a weekly basis. Here is what I see.

The S&P 500 and the VIX are like Shakespeare’s Romeo and Juliet. They are two lovers that cannot remain separated over time. Their respective lines on the chart must eventually meet. They must be together. We can see from the chart that they were together in 1995 and they separated. They joined again in 2002 and again separated. They came together again in 2009 and once again separated. These are seven-year cycles and they should join together again in 2016. This means the VIX should rise and the S&P 500 should fall. Don’t panic. This won’t happen until 2016. Until then, the stock bubble will continue to be inflated by central bankers who are desperate to grow their power. Their whip of obedience is the stock index.

Of course, Romeo found Juliet asleep and thought she was dead. He then committed suicide. Juliet awakened to find Romeo dead and she then committed suicide. It is a depressing story. Neither character lived to enjoy a ‘happy ending’. 

Today, the VIX is currently working its way toward 20-year lows and the S&P 500 is currently working its way toward 20-year highs. I suppose the next few years will see this pattern play out until the bubble finally bursts in 2016. The central bankers are working diligently to inflate the bubble while debt continues to grow on every balance sheet. And yes, US corporations do have an enormous amount of cash in the banks but they also have an all-time high debt load at those same banks. In three years, the US will likely have amassed close to $20 trillion in quasi-sovereign debt and the EU nations will still be in debt-induced recession. What will pop the bubble? Maybe we run out of central bank liquor. Who knows?

But what should we do right now? Party on, of course. The liquor is still flowing and tomorrow is a holiday. We don’t need to get sober yet. I believe the central bankers will keep pushing the stock indices to new highs and the VIX will respond by falling to new lows. But here comes the warning. As the chart tells us, these two indices will eventually get back together. Probably around 2016. The scenario might be that the S&P 500 will climb to maybe the 1600 level on central banker leverage that will be supported by ebullient economic news regardless of reality. 2016 rolls in and the bubble bursts taking the VIX up and the S&P 500 down 50% below its 1600-level highs. But for now, the central bankers are operating distilleries, breweries, and stills. The VIX is just warning us that real heartache will once again befall the precious stock indices. but why worry about the future? The Fed is our friend, right?

20 years weekly - SPX in blue, VIX in red
Chart courtesy

Disclaimer: The views discussed in this article are solely the opinion of the writer and have been presented for educational purposes. They are not meant to serve as individual investment advice and should not be taken as such. This is not a solicitation to buy or sell anything. Readers should consult their registered financial representative to determine the suitability of any investment strategies undertaken or implemented. BMF Investments, Inc. assumes no liability nor credit for any actions taken based on this article. Advisory services offered through BMF Investments, Inc.