Is the VIX signaling a sell?

A reader posted a comment asking me about the VIX. I gave her a quick reply, basically noting that it is moving up (indicating rising volatility) after touching the “complacency” level of around 12 recently. Today, I thought it might be interesting to examine a pattern on the VIX that might indicate the potential for a pullback very shortly.

To start, I’d like to note that I view the VIX in a few ways. I like to look for macro market extremes.  I also look at the VIX for near termed patterns.

MACRO VIX extremes

If you follow this blog regularly, you know that I post something I call the “Bear-o-meter” (BOM) every month. That meter has 11 indicators within it. Its purpose is to measure relative risk vs reward for the US markets. Most (not all) of the indicators in the BOM are longer termed in outlook.

One of the longer termed indicators falling under the “sentiment” category is the VIX. The VIX, in a nutshell, reads total option pricing premiums. When option premiums are high, it indicates investors are paying-up for anticipated good, or bad news. Typically, option premiums on puts (bearish bets) expand aggressively when fear is in the air. When everyone is complacent, premiums, particularly on puts, shrink. Below is my long termed monthly chart (1990-present) with my two levels used to measure macro sentiment extremes via the VIX. A move to the horizontal lines tends to be a sign of complacency (<12) or fear (>33).

From a macro point of view, we recently saw a test of 12 – but not below that level. Historically, true market tops are marked by levels well below 12 for longer periods of time than the short test we just had.

Conclusion: no current signs of a major top, according to the VIX

Near-termed VIX pattern

In a low-volatility environment like the one we’ve seen since 2023, the VIX tends to stay BELOW 20 (orange horizontal level, chart below). A VIX below 20 represents a low-volatility bull market.

When the VIX moves ABOVE 20, it indicates higher volatility. Take a look at 2021. When the VIX moves above 15 but is still below 20, it can suggest a chop within a bull market, and possibly a pending correction.

When it moved ABOVE 15 then 20 in late 2021 & in 2022, it told us that volatility was increasing. ValueTrend identified that move, along with signals from other indicators in our BOM in this blog as another reason to raise cash in April 2022.  As the bull trend broke, we raised even more cash that spring. This helped us avoid the vast majority of the bear market that year.

Conversely, the VIX started bouncing around in its upper end of the range (best seen on the monthly chart above) as the market moved into a bear through 2022. When at that level, AND when other BOM indicators flashed oversold  AND bottoming trend indications, we moved back in.

As I always teach, there is no holy grail indicator. Its always: Trend.(!), Sentiment, Breadth, Momentum, Seasonality and Value. VIX signals (sentiment) are just one signal.

Where are we now?

The VIX just moved ahead of 15. I’d expect it might keep moving higher, indicating at the very least some chop. Its not a bad ideal to stay a little cautious at this point. Are you listening, holders of magnificent seven stocks? If we see the VIX push above 20 that would mean we are in a high-volatility environment that is correcting more fiercely. How long that correction lasts, if this happens, is not predictable. My two cents is for a move to about 20 and a probable stop near that level. But, I don’t predict. I do prepare. That’s what you do too, right?

Buying after a correction

A move above 33 then would suggest an end to a period of big volatility/ market pullback is near. Again, look at this in combination of trend, and other factors. My BOM does it for you. If VIX fear signals happen in a bullish or neutral BOM environment, we should likely become quite bullish. This, given it signals a panic environment ready for a flush-bottom. The trick is to leg in, and when trend changes (mind your peaks and troughs!) , leg in more aggressively – as ValueTrend did in 2022. Again: Especially if we see the other indicators on the BOM move into a bullish score (5+).

The recent BOM reading was a mild-bearish score of 3.

Speaking of sentiment indicators like the VIX…

Behavioral finance

I’m doing a free webinar with the MoneyShow Wednesday, April 17, 2024, 10:40 am – 11:10 am EDT.

I’m covering my favorite topic – contrarian investing and behavioral finance.  The webinar will draw from my most recent book, Smart Money/ Dumb Money, and I promise to inject some humor into this fascinating way of discovering market risk / reward tradeoffs.

Here’s the link to register. 

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