Only Abatement of Risk Aversion Will Stop VIX from Further Fall - JP Morgan Strategist

Since it was introduced in 1993, the VIX, often known as the fear index, has never seen levels like the recent record closing of 79 and intraday high of 90. At 90, the VIX implies an expected 25% change in stock prices in the next month, according to JP Morgan equity strategist Thomas J. Lee.

“Whether this is fund selling in front of redemptions, or some other factor, we have no visibility,” he told clients. But with investors clearly remaining risk-averse and uncertainty continuing to be at elevated levels, Mr. Lee thinks it is reasonable to expect the VIX will fall once credit markets begin to function better.

The conclusion of the U.S. election, better visibility on the macro economic situation and an easing of redemption-related selling should also help. However, the strategist said he is more confident the VIX will decline than he is in a short-term direction for equity prices.

Mr. Lee said in a research note:

Corporate earnings this week [have] not provided great insights, even from the earnings calls, as it seems overall business activity has continued, despite the conditions in credit markets for the past three weeks.

While equities are trading at 11 times JP Morgan’s 2009 estimates, which is historically a trough valuation, he said valuations will not define the bottom, an abatement of risk aversion will. And while Mr. Lee expects stocks to be higher by the end of the year, “a new low in the interim is possible.”

He highlighted the ten S&P 500 stocks most positively and negatively correlated to the VIX. If it declines as predicted, the negatively correlated names should benefit the most.

They are: General Dynamics Corp. (GD), Air Products & Chemicals Inc. (APD), Tyco Electronics Ltd. (TEL), Torchmark Corp. (TMK), Baker Hughes Inc. (BHI), Thermo Fisher Scientific Inc. (TMO), Tyco International Ltd. (TYC), Caterpillar Inc. (CAT), IMS Health Inc. (RX) and Alcoa Inc. (AA).

The most positively correlated names are: UST Inc. (UST), Barr Pharmaceuticals Inc. (BRL), Wells Fargo & Co. (WFC), Family Dollar Stores Inc. (FDO), Rohm and Hass Co. (ROH), General Mills Inc. (GIS), Anheuser-Busch Cos. Inc. (BUD), Campbell Soup Co. (CPB), Nicor Inc. (GAS) and Amgen Inc. (AMGN).

Comments

[Smarty_Pants:]

"At 90, the VIX implies an expected 25% change in stock prices in the next month, according to JP Morgan equity strategist Thomas J. Lee"

Given that the DJIA has fallen nearly 25% in the past month, that's probably not such a big surprise.

The VIX is calculated based on the option premiums of near the money calls and puts I believe. Given that volatility expectations are what drive the time-value portion of such options it would stand to reason that VIX levels would reflect the very recent moves of the underlying.

You could probably estimate VIX very closely by computing the recent standard deviation of the underlying index and scaling it. I guess it's just easier to look at one number instead of doing the work yourself.

2008 Oct 28 03:28 PM