Back in late 2007, when I still worked for CIBC Wood Gundy, one of my clients was interviewed by the Financial Post. The title of the article was “Contentedly Contrarian”.
In the interview, my client was glowing about my contrarian investment style—I had saved him, and other clients, from the 2006 income trust meltdown, and was at the time of the interview becoming bearish on oil. It turned out that I was right about oil too—a year after that article was published, oil fell from a peak in early 2008 at $145/ barrel to a low of below $30. For the record, I re-bought into oil after that crash as it based and began to recover in the $30’s.
Contrarian investing, at least from a quantitative viewpoint, should be backed by sentiment indicator studies and volatility studies. Merely going against the crowd for its own sake is dangerous. Today’s blog will take a look at a classic contrarian investment tool. It’s a volatility indicator known as the “VIX” (Volatility Index). For those not familiar with this indicator, go to Investopedia or stockcharts.com to learn about its computation.
The VIX is best used as a relative measurement tool. In other words, you want to see how it moves relative to its recent history to try to determine if the market is not expecting too much volatility (a contrarian sell signal) or if its pricing in a lot of future volatility (a buy signal). I’ve marked on the VIX chart below some recent trading ranges for this measuring tool. As you can see, we’ve gone through two volatility ranges since the bull market began in 2009.
The first range (2010 – 2013) saw investor “complacency” at a VIX level of about 15, and investor “fear” at a VIX level of around 27. This range did have outside spikes to the upside, but the bulk of the movement was between 15-27. So a trader would look at movement in or around either of those areas as one more piece of evidence a buying or selling opportunity. Keep in mind that the VIX must never be the sole indicator that triggers a buy or sell. Always defer to the market chart patterns and indicators as your main trading tool.
The next range began in early 2013 – signalling the start of the recent non-stop uptrend. The VIX range seems to have changed from 12 (complacency) to 18 (fear). Interestingly, the VIX got to a new low level of complacent at 10.3 (circled on the chart), before the recent correction. Presently, we’re approaching 12 again. Complacency has set in. To me, this signals that traders should keep an eye open for another corrective blip in the coming weeks. However, if the VIX repeats its July performance, that may not happen until a level of 10 or lower, is approached.
I remain a long termed bull, but short termed cautious investor due to factors such as the current low level of the VIX indicator.
Keith on BNN
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Also the VIX has failed to get above the 200 week MA on 7 attempts since early 2012, including this most recent market dip. It’s been very reliable
Keith: You speak about contrarian investing in broader terms by referring to the Vix or sectors such as oil. Would you also consider individual equities in this discussion? I am thinking of the domestic pipeline sector and how stretched the valuations are?
The pipelines are due a correction – they are overbought. But the trend is up. There isn’t a sentiment indicator that tracks just the pipelines – but I don’t think that its “all the rage” to own them–thus, I don’t think they are in a bubble. When income trusts and oil were in their respective bubbles–people were writing entire books on how “the world was going to get smaller” (oil bubble) and putting out dedicated research publications strictly on which trust to buy. Further, every company out there was converting to a trust.
Those atmosphere’s were much different from pipelines–which are simply overbought within an uptrend. Nobody’s writing a book on pipelines, and uniformed investors are not yet beating a path to brokerage houses to buy them. There are no mutual funds entirely dedicated to pipelines yet–that’s usually the sure sign! Funds tend to attract unsophisticated aka “dumb money”–and those guys buy what is hot –usually too late.
Re VIX on individual sectors–not sure if there is one–its more of a broad market indicator.