Monday Edition- Historical Analysis of The Volatility Index (VIX)

By Yaser Anwar, CSC of Equity Investment Ideas

This week I’d like to present a Historical Analysis of The Volatility Index to help you answer- "To Buy or Not To Buy?"

"Should we buy the dip or wait for a bigger correction?" is the question most investors have been asking themselves, given the precipitous decline of the markets this past week. During the week’s special report I talked about a little history, today I’d like to talk about some more. Analyzing the trends of the past 50 years in S&P, I came across results which look bullish.

When a decline of 2% or greater occurs, markets have generally rebounded smartly within a week of sharp daily pullbacks, with a large-cap bias. When markets have declined 3% or greater, S&P has been up three months later with a probability of 80% of the time.

With the Volatility Index closing around 18, a historical analysis of the most recent correction (prior to Tuesday), May ’06, the VIX tested the 20 level till July, alongside bull markets of the 90s and since ’03, every time the VIX has hit 20, has been a very bullish indicator for stocks in the long-term.

So far the underlying fundamentals have not changed significantly; we’re still having record no. of quarters with double digit earnings growth, dividend increases, and lots of cash on corporate balance sheets, but we’re seeing economic data; Jobless claims up, residential investment down 19% annually, weak Jan durables. I would suggest keep an eye on the economic data, especially the VIX for its testing of the 20 level.

Also, with the return of volatility to levels seen in May–June 06, keep an eye on the Russell index (corrected by 14% in May-June 06). Why? As a index future derivatives trader, its common to look for confirmation in the Russell Futures (ER2) during the day, to compliment the movements of the S&P (ER) due to their positive correlation. Furthermore, the Russell represents the risk appetites of institutional investors, and most importantly during high levels of volatility favors large-cap stocks, as they are more safe with lower beta ratios than small-caps.

Lastly, I’d like to present a historical analysis of the S&P 500’s Cash %, ex-Financials, which shows that cash on balance sheets is well above the pre-crash levels of ’87 and 00.

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