Did followers of the VIX index see it coming?August 31, 2015
Did followers of the VIX index see it coming? Probably not, the VIX index is not a good leading indicator for market volatility. The VIX is the most widely accepted method to measure or gauge market volatility. The philosophy of the VIX is “when the VIX is high it is time to buy.” This statement may have some historical evidence of applicability however interpreting the VIX index as a leading indicator would be a gross over statement. Evidence suggests the index is a coincident fear indicator (near perfect correlation with market indexes such as the DOW), or lagging, rather than predictive. The VIX index responds to sharp market selloff such as the market crash in the opening minutes on Monday Augsust 24th , but does not provide information on when and by how much volatility might start to increase or decrease and certainly no information about market direction if volatility increases. Volatility equals risk not necessary a down market or a market crash.
On Monday the 24th, in the opening minutes, the Dow fell over 1000 points before rebounding to just a 102 point decline at the peak of the day, before finally landing down 588 points. If you follow the VIX index, it saw the greatest one week jump in history soaring to 38, significantly higher than its long-term average of 20. If the VIX index was truly a predictor of market volatility, the VIX should have moved or jumped well before the market did or at least demonstrated a sharper increase in the weeks preceding the 24th. To be fair, the VIX did slightly start to increase the week prior to the 24th as the market declined. However, such a move does not seem significant when taken in context with where it had been earlier this year. In early July, where after 11 days the Dow was down 629 points (-3.47%), the VIX was actually at a higher level than the recent weeks prior to the 24th. The VIX index actually fell from its peak of 19.97 on July 9th (after which the market moved up for the next 6 days) and remained relatively low and stable until the Friday prior to the 24th, where, in just 5 days, the Dow fell 1674 points (-9.5%). All-in-all the slight uptick in the VIX in the week prior to the 24th could reasonably have been seen as just a return to earlier levels, not so much a predictor of a big market move.
FDx Advisors does not rely on the VIX index for its VisX program yet did anticipate that the market would correct. Obviously we did not know the exact date, nor are we stating we predicted or are predicting a market crash, but our model has been telling us to be cautious and expect a market correction with increased volatility or risk in the market. These types of corrections with corresponding volatility are not unusual. Valuations through the FDx model’s lens have been high and with the impending increase in interest rates, uncertainty from China, and the fact that market indicators have shown for some time that the economy is in the late upswing of the business cycle,which is typically followed by a decline in equity prices, we have felt it better to remain cautious. Our VisX portfolios as a result have been positioned for an environment such as we are currently experiencing.
In these high volatility environments, investors tend to react with behavioral biases. It is during these times that it is most prudent to maintain your conviction in order to avoid the all too common “buy high sell low” strategy. Investing for the long-term and diversification are the keys to weathering through all types of markets. The focus belongs on maintaining a portfolio that is appropriate for your goals rather than one that is appropriate at the time. FDx Advisors has constructed the VisX program firmly planted in these philosophies and therefore was well positioned for the events of the last two weeks. Instead of reacting to short-term events we stand by our strategic allocations and remain committed to the long-term view of the VisX Program.
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