Market Will Bottom When VIX Finds a New Top

I don't mean to throw a wet towel onto yesterday's China Syndrome rally, but I believe that this is only a temporary breather before the next leg down. Now I'm not the only bear in the forest—not by a long shot—and it seems as if I and my other furry brethren are struggling to answer the burning question of the moment: “Where do you think we'll find a bottom?” The best answer I can give to that is: Try a restroom.

Nobody knows anything right now
I don't mean to be flippant but I do think that the right answer is: Nobody really knows. The fundamentalists for sure don't know. Yesterday on CNBC, one reporter (Bob Pisani?) said that analysts can't even come up with a reasonable guesstimate as to where earnings will be in 2009, which makes predicting any sort of support level impossible.

The technicians don't know, either. My charting program only carries ten years worth of price and volume data for the Dow Industrials and nineteen years for the S&P 500. The Dow has already broken through major support at the 7800 level and I don't have enough data to discern the next stop. The S&P recently blew through its 800 major support level as well as minor support at 755. According to its monthly chart, the next points of minor support are down around 670 and then 450.

Fibonacci levels

Technicians often resort to Fibonacci levels which are used in Elliot Wave Theory. Using the S&P 500 as an example with 1550 being the market top and 0 being the bottom, we get support levels around 960, 775, 590, and 365. The problem with Fibonacci levels is that they're not always accurate, and I especially have a problem using them over such a long time frame.

Aren't there any other places we can go to get some clues as to where a possible bottom might be?

How saving money will put us in the poor house

In his excellent column that appeared on MSN Money Tuesday, Jon Markman used the Levy-Kalecki model of economic behavior to explain how high levels of saving and a decline in borrowing can lead to the devastation of corporate profits, a situation we could very well find ourselves in. Using this model, Markman came up with a couple of market scenarios--both rather grim tales. He said that if households save as little as 7% of their incomes, the S&P 500 could sink as low as 550 and the Dow as low as 5,300. If the wealthy are taxed per Obama's plan and savings rates go to 10%, the Levy-Kalecki model suggests that corporate profits will be slashed by 50% from their 2007 peak. Depending on whether investor confidence or fear prevails, the S&P could either end up around 755, a little higher than where it is today, or around 420, a lot lower.

I'm casting my vote for the fear camp and here's why.

The reason for another market downturn

The reason I think the market still has a ways to tumble is because of the VIX, the volatility index. The rule of thumb is that the more uncertain the market, the higher the volatility. Even though the volatility has been high lately, it's still nowhere near where it was last autumn. Below are daily charts of the S&P 500 and the VIX.

You can see that the VIX roughly inversely mirrors the movement of the S&P. When the S&P made new lows last October and November, the VIX made new highs (around 80). But the S&P has dropped well below those levels and what has the VIX done? It hasn't even come close to making any new highs. This divergence is a signal that the market has a lot more room to fall.

The answer to the question

So, where will we find the market bottom? The answer to this question is not where, but when. We'll find it when the VIX forms a new top, and it doesn't seem to be in a hurry to do that. So fasten your seat belts 'cause it's going to be a bumpy ride!

Disclosure: No positions.

Comments

[Beach Bubba:]

Duh!

Mar 05 07:42 AM

[contracontr...:]

"This divergence is a signal that the market has a lot more room to fall."

The VIX and the S&P have acted similarly between July 2002 and March 2003. It was actually a positive indication for the market going forward.

Mar 05 08:13 AM

[Finance User:]

Why should the Vix be high.Everybody is waiting for the reversal. All the bad news is more than priced in the market and nobody cares about further bad news anymore and also nobody wants to miss the rally. So prices stay more or less where they are.
With the first signs of good news the move upwards will be unstoppable.

Mar 05 09:39 AM

[ain't no fo...:]

Many major bear market bottoms such as we saw in the dotcom bubble meltdown concluding in 2002-2003 are marked by two lows.

The first is a MOMENTUM bottom characterized by a terrifying collapse in stock prices as the investment community reacts in fear and panic to a new set of news and earnings dynamics and is forced to rapidly throw out all their preconceived notions about the direction of prices as the bubble starts to deflate. The panic - driven collapse is also marked by a huge spike in the VIX. That occurred in October 2002 and it occurred in Oct/Nov 2008, when many investors put on what was later called the Armageddon trade.

The second low is set later, and it is the PRICE low. It is not accompanied by a new spike in panic as the prior momentum low fairly discounted the extent of the carnage to be anticipated in prices and economic conditions. It is a grinding, frustrating process this time as the last of the sellers finally throw in their hand and dump stock. VIX does not approach its old levels because there is no really unanticipated terrible news, just a seemingly endless supply of day-in, day-out bad news. The markets priced in that second low in March 2003, and market conditions and charts are showing that the are some similarities now as then, and perhaps we are grinding our way to a price low in the March/April '09 timeframe.

I believe the VIX is reflecting a lack of any NEW fears at this time, and thus trading at a reasonable level for market conditions.

Mar 05 09:47 AM

[raytayzmd:]

...aaaack!...good thing I learned to keep a wastebasket close by when I'm reading seekingbabble -- uh, seekingalpha..."VIX" can tell you exactly two things about the presence of a market bottom: "jack" and "s__t"...and even disregarding the old adage about never trusting anyone whose eyes are less than an inch apart, Markman's analysis of the "Levy-Kalecki model of economic behavior" is nothing more than that -- an analysis of a MODEL...and models are built using HISTORICAL data -- a process otherwise known as curve-fitting...and ANY statistician will tell you that curve fitting's predictive reliability depends upon stability of input parameters and constancy of the coefficents -- for example, you can predict the behavior of a gas if you know pressure, volume and temperature...but that does NOT apply to the economy or stock prices where coefficients and inputs are constantly changing...if it WERE true, then all economists would be rich because they are WIZARDS at modelling HISTORY...the best thing to do with ANY economist's opinion is ignore it.

Mar 05 10:29 AM

[Fred Voetsch:]

Volatility has more to do with the rate of decline than the level the market is at so your theory that you can predict a market bottom by a new high in the VIX is seriously flawed and in fact, just looking at current levels shows you how flawed it is.

Mar 05 01:03 PM

[Beach Bubba:]

somewhere today, I saw a post that said, in effect, "If you don't like the way things are going with your stock...turn your chart upside down...

Techno gibberish makes me tired.....just do the work.

Mar 05 01:22 PM

[OldLimey:]

Two thoughts:

1. A spike in the vix prompted by something that isn't yet priced-in (e.g., a major and unexpected corporate failure) could accompany a new and final bottom. On the other hand, as wpdragon explains very clearly, we might just grind our way south without any fear-induced spike.

2. Personally, I wouldn't base a fib study at zero. I'd run it up from a major low to a top and look for retracements on that basis.

Mar 05 02:13 PM

[Philip7:]

I've frequently commented on the fact that economists are really good at explaining the past but so horrible at predicting the future. This is the most lucid explanation of that phenomenon that I've come across. Thanks.

On Mar 05 10:29 AM raytayzmd wrote:

> ...aaaack!...good thing I learned to keep a wastebasket close by
> when I'm reading seekingbabble -- uh, seekingalpha..."VIX" can tell
> you exactly two things about the presence of a market bottom: "jack"
> and "s__t"...and even disregarding the old adage about never trusting
> anyone whose eyes are less than an inch apart, Markman's analysis
> of the "Levy-Kalecki model of economic behavior" is nothing more
> than that -- an analysis of a MODEL...and models are built using
> HISTORICAL data -- a process otherwise known as curve-fitting...and
> ANY statistician will tell you that curve fitting's predictive reliability
> depends upon stability of input parameters and constancy of the coefficents
> -- for example, you can predict the behavior of a gas if you know
> pressure, volume and temperature...but that does NOT apply to the
> economy or stock prices where coefficients and inputs are constantly
> changing...if it WERE true, then all economists would be rich because
> they are WIZARDS at modelling HISTORY...the best thing to do with
> ANY economist's opinion is ignore it.

Mar 05 02:30 PM

[AndrewBaker:]

We're still going down, a long way yet as the VIX is the sum total of all the worries that abound, and the worried sell: not buy.

Mar 05 03:40 PM

[RiskReturnO...:]

Could the lower high on VIX be partly due to new financial instruments that track VIX, and as more and more investors are actually trading the VIX (long or short), the VIX as a "investment vehicle" is becoming more liquid & market efficient, so perhaps will not spike / dip as much going forward?

Any thoughts?

Mar 05 07:35 PM

[mrbill:]

Here's what's in the works:

* Massive bankruptcies, corporate and municipal

* More job losses

* Earnings that keep going down
(it's priced in, sure...)

* Massive commercial real estate bust
(the next shoe, hanging by a thread, IMO)

* Government intervention making things worse

* Taxes going up

* Social breakdown/civil unrest

* Threat of war(s)

Nevertheless, I'll just let the VIX tell me when to buy. Sure.

Mar 05 08:52 PM

[squark62:]

my thought is the VIX has been trending in the fashion dr kris describes before the VIX tracking ETFs came online. even still, the $volume is so small there is little possibility for them to efect things one way or another.


On Mar 05 07:35 PM RiskReturnOptimizer wrote:

> Could the lower high on VIX be partly due to new financial instruments
> that track VIX, and as more and more investors are actually trading
> the VIX (long or short), the VIX as a "investment vehicle" is becoming
> more liquid & market efficient, so perhaps will not spike / dip
> as much going forward?
>
> Any thoughts?

Mar 05 10:32 PM

[Smarty_Pants:]

VIX is calculated from the pricing of options on the underlying index.

The only way VIX changes is when the "relative" option pricing changes compared to the market index changes. I doubt very much that any VIX ETF will have much influence on the index options.

If it does, I'd appreciate it if someone would explain the arbitrage trade used and how it alters the index option pricing.

As for the market, it will bottom when it bottoms. The only thing anybody can do is to wait and see when it starts going back up again and sustains the move.

If we keep getting lower lows and lower highs, I wouldn't expect a rally to last very long if we see one. Prices will have to make higher highs and higher lows a time or two before you see any sustained progress in the market, that includes indices and individual shares.

I don't expect to see much positive market action for some time, but that's just my opinion. I've been wrong before a time or two, so I wouldn't be surprised to learn I'm wrong in that call, but until I see evidence to the contrary, the trend is down. Position yourselves accordingly.

Mar 05 11:43 PM

[max12345:]

The only thing I fully agree with in this article is its introductory sentence which says that "nobody knows anything right now" (and often enough, also ever) To be consistent, the article should have stopped right then and there and wished us all great luck with our respective personal crystal balls and guessing strategies.

With respect to Fibonacci, he was a great Italian medieval mathematician who died in 1250. As brilliant as he undoubtedly was, might we (or the Elliot Wave theory technicians) not be scratching the bottom of the barrel?

At various points in the future (by the end of 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2020, 2030 and maybe even 2050) (and NO, it is not a Fibonacci string or sequence) we will know who had been right and who had been wrong and maybe even a bit about why. (if we live that long)

And hopefully bears and bulls alike (and would all the rest of us in the middle who are neither perhaps be just plain turkeys?) (at least we taste good on Thanksgiving) will not then claim they had been able to see the forest through the trees (or the habitat through the forests) (marginally more probable) nor had a theory or a predictive model that was robust and valid enough to indeed be able to predict something (or just anything)

What to do then?

Keep trying to enjoy your personal life (or do whatever else you think you were placed on this planet to do -by God or by Darwinian evolution- every single day, since, unlike money which can be made back, any days and moments you waste -and hence lose- are truly lost forever... and if you really want to....also hope like hell that everything will turn out o.k. (usually it does)

The second option is to fret, worry, think about your portfolio 24/7, get more gray hair, get stressed and overeat, trade in and out five times per day, suffer anxiety fits, take tons of prozac, pray that the VIX will go up or down, and basically destroy your present life in the hope of some better future that may or may not come.

Today a few of Mahatma Gandhi's personal belongings are being auctioned off in New York and I just heard that one of the offers from some guy in India (who obviously has too much money and too little sense) and obviously also did NOT benefit from India's Independence, was for well over a million dollars. (for a pair of old sandals and some beads).

So one thing is for sure. The World has NOT learned and taken on board Gandhi's great teachings.

So another thing one could do is to start walking across the U.S.A.. as one waits out how markets will do. I guarantee that by the time you are half way across the TRUTH will come to you. (not to mention that you will be able to see for yourself some of those wind and solar farms already installed in New Mexico and Arizona that might convince you to invest in a Greener and more sustainable Future (and you may even meet some wise old Navajos nearby that can offer a truly different perspective)

From the time of the Egyptians, Babylonians, Ancient Chinese, Ancient Greeks, Ancient Africans and Ancient American "Indians" good Philosophy has always trumped good Markets. (and definitely Donald Trump)

Mar 05 11:48 PM

[TeresaE:]

"high levels of saving and a decline in borrowing"

Two points:

1. We aren't 'saving' money, we are paying increased utilities, food, insurance and credit card payments on less earnings. And because none of those realities are reflected in government statistics, well paid "experts" write fluff about things they don't understand.

2. The reason there is a "decline in borrowing" is because starting in 2007, when the mandatory minimum payments were doubled it immediately sucked over $50 BILLION a MONTH out of our "expendable" income. Then, the banks to make up for lost "revenue" (because theoretically, it should have reduced our consumer debt) doubled or tripled interest rates on people that PAY their bills on time.

Us smart ones quit using the damn cards and found ways to yank our business from the banks. Sorry, but you promise me 5%, entice me to borrow $10,000 to fix my furnace, then because the government changes the rules, jack my interest rates up to 17% and then you WONDER why your default rates skyrocket?

The banks asked for the change, the government obliged and so began the descent into hell.

No family supporting jobs for the masses and then yanked credit, which is what the majority of our country was living on as the manufacturing and other industries slowly packed up and left. Housing & cheap credit hid the reality for a few great (for some) years.

And now we "question" why the Dow can't find a "bottom"?

Tell you what, go to the third world, ask the new American corporate workers how much they make and if they can afford to buy the crap they produce for us, and come back and tell me where bottom is.

Every good paying American job lost is the loss of a good buying CUSTOMER.

The Dow has a long way to go.

Mar 06 12:06 AM