What the "Fear Index" Is Saying About the Market

The market closed roughly flat on Wednesday, with the S&P 500 a bit lower, and the Nasdaq a bit higher. Once again, volume was pathetically low. NYSE volume was the lowest it’s been since the Friday before Labor Day weekend.

There was continued angst yesterday in the credit markets. Most people don't follow these indicators, but if you look at things like the LIBOR swap rates or the TED spread, both were high and rising on Wednesday, which is a sign that global credit markets are still extremely tight.

As for the equity market, I want to take a look at the Volatility Index [VIX], or the "fear" index. The VIX closed lower Wednesday, which was a good sign. However, it is still very elevated at the level of 35.19. A look at the chart below shows that the VIX has had roughly a week's worth of closes above the 30 level, a rare occurrence.

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Back in March 2008 (see below), at the "BearStearnsbottom," the VIX also spiked above 30. But in March, it only had two closes above the 30 level before reversing lower. That signaled a good buying opportunity.

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The same goes for August 2007, when there was another panic low in the market spurred by the initial signs of this credit crisis. Last August, the VIX again broke above 30, but only had two closes above that level before reversing lower. Again, this was a good buying opportunity in the market.

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The last chart goes all the way back to October 2002 to find another period when the VIX spiked north of 30. October 2002 was the bottom of the last great bear market. Notice that back then, like now, the VIX not only got above 30 but also spiked all the way to 42. It also reached 42 last week.

You can see that the VIX stayed around these elevated levels for a couple of weeks, as there was widespread disbelief that the market had bottomed. However, eventually the VIX began to work its way lower and signal that fear had peaked and was easing. This was probably the best buying opportunity of the last 25 years.

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I am not saying that last week was THE bottom of this bear market. We will only know that with hindsight. But I do think that if Congress acts quickly to pass this plan, the markets should stabilize. I am sure that the powers that be would like to do everything in their power to support a firmer market before the election and into year-end.

On Tuesday, I took profits in the remaining SPX hedge I had on. So I am taking off my downside protection and looking for signs of stabilization in the market. I see lots of attractive opportunities in the market, but do not want to put cash to work until I see more positive price/volume action in the markets.

Comments

[Schweizer:]

Congress will pass the whole amount because it would be suicide for them if the market tanks before the election and they hadn't given the plan their full support, especially the Dems. Passage commitment, perhaps today or Friday, will be the trigger for a short term rally back up to the 11,700 level on the DOW, where it will then fail, yet again.

One last chance to get the hell out of Dodge.

2008 Sep 25 07:38 AM

[Pauly B:]

The 4th quarter will really stink. The jobs numbers will only get worse. How can it improve each day this credit crisis continues? How many more layoffs and bankruptcies happen.? Even with the infusion the banks will be ultra tight into the future for some time. I am not optimistic we are anywhere near a bottom, yes we will have rallies, but the bear market will be with us for at least a good year or too.

2008 Sep 25 08:18 AM

[daytrader:]

jordan,
a great article!you back up what you say with facts.however,i do agree with Schweizer&Pauly B.we should rally about 600 to 700 points&then based on the world we live in,back down to about 9500.this is a global recession we're in.Schweizer;11700,yes... B;a bear market for a year or two.yes.these guys should be on cnbc!

2008 Sep 25 09:05 AM