The VIX Index of implied volatility in prices of stocks driving the S&P 500 index (SPX) is now at its highest level in over 6 months. In mid-late July of this year, the VIX crested at 20.47, while the SPX was dipping to 1338 from earlier 2012 highs approaching 1420.
Since then the SPX index has risen +9% to the 1460 level, first in two months to mid-September, and repeatedly to mid October. It then retreated -4% to 1402. These are all generally known facts.
What is not generally known is the anticipations of volume market-makers for the potential future of the VIX now, or what it has been over the past 3 months, and what that may mean for the S&P 500 in the next 3-4 months.
Here is what they have seen since our last review in late September in The Hoax Of VIX-Based ETFs As Risk-Proxy Investments.
(used with permission)
The comparable behavior of market-makers hedging directly in the SPX is as above. Neither of these pictures are conventional high-low-close "charts." They are both records of the ranges of price being forecast by implication of the on-the-date actions of market-makers, hedging the at-risk exposures to firm capital required by their assigned roles.
The September article noted that subsequent price behavior in the VIX had far better correlation with preceding prices of the SPX than the reverse. But to get a credible indication of subsequent SPX price gains, the market-makers' forecast balances between upside and downside prospects for the VIX has been a help.
That balance is measured by the Range Index, a metric noting how far the current market of the subject of interest, in this case the VIX, is above the bottom of its forecast range as a percent of that range. Low RIs (below 50) indicate larger upside price change expectations than downside ones.
In the visuals above, each vertical line is a range forecast, and the Range Index relates the then current market price (heavy dot) to the range.
The September article noted why the behavioral analysis of the market-makers' expectations were more robust than the mere historical analyses so often offered by technical analysts: The forecast ranges produced by market-maker actions contain their forward-looking, self-protection commitments of real capital, necessary to ensure their jobs. Such actions are not mere hopes that the past may be repeated, but are actual judgments about what is likely to happen, as they see it from their exceedingly well-informed positions.
As shown in the September article's next-to-last table, when VIX Range Indexes move up above 45 they tend to be followed by double-digit annual rates of gain in SPX prices in the next two months or more. In the past 4 or 5 weeks, the VIX Range Index has risen from near zero to 36 currently (12/27). Negative perceived prospects for the SPX appear to have heightened this trend.
We will continue to monitor these trends as year-end developments unfold, and intend to pass them on as their significance increases. At present a general equity market buying opportunity appears to be developing.
With interest rates being severely depressed by US Government actions (Treasury and Federal Reserve), asset allocations to income-producing instruments are at risk of capital loss when those rates rise, returning to realistic levels.
At a time when equities are indicated to be depressed to levels not likely to continue, this looks like a good time to review asset allocation decisions, favoring increases in equities and reductions in income oriented instruments.