Monthly Archives: July 2008

SPECIAL REPORT – ’PANIC’ as Defined by the VXO Index

I hate to keep beating this dead horse, but I want to be certain that all of the chatter about “capitulation” doesn’t lull any of my subscribers to sleep here.  Again today, in the Wall Street Journal, I see this complete misinformation about bear markets ending with VIX readings at or above the 30 level.  This is simply not true but for some reason, unknown to me, these financial page writers and Bloomberg and CNBC commentators have been relentless in perpetuating this misconception over the past several months. 

Number one, it’s never been as easy as sitting back and waiting for a magic VIX reading and them pushing your chips “all-in”…and number two, the market has a way of proving the majority wrong.  Never before have I seen such a fixation on the VIX with so many market participants saying we might have already bottomed or saying “I’d like to see just a little more panic reflected in the VIX” before I call “a bottom.”  The BAM model says they’re going to get their wish (a high VIX reading) but when this panic comes they’ll be caught flat-footed, cashless, and crushed.  They’re simply too complacent here and seem oblivious—technicians included—as to exactly how dangerous this market set up really is. 

Please review the charts below.  I use the VXO (the original volatility index) because it provides data on “the big one” in 1987 and that, I believe, helps us to better establish a “high water mark” as opposed to using recent “market panics” represented in the newer volatility index— referred to as the “VIX.”   Remember, the FED intervened during the LTCM debacle and that set the stage for volatility spike readings that have subsequently fallen far below what might otherwise have been considered as “panic readings” if people were left to sort out market inefficiencies all by themselves.  As you’ll see below, the “Crash of 1987” spiked the VXO to 172.79, the “Asian Currency Crisis” spiked us to the 55.48 level, the “LTCM Crisis” spiked us to the 60.63 level, and then 2001 and 2002 only raised the VIX into the high 50’s (because the market was thankfully and correctly closed after 9-11-01).  Now, during 2008—with write-offs over 50 times higher than during the LTCM debacle—these guys think a VIX reading of “just over 30” will bottom us?  Come on. 

The question of whether or not the FED has indeed created an environment of complacency (a moral hazard) has been well established in my work so I’m assuming the worst which implies a catastrophic event for the financial markets as we move through the coming years.  I’ve said this before but it might be worth repeating here.  The BAM model sees multiple crashes coming as we trade forward as opposed to a single 1987 type event so even after we see a spike high in volatility over the coming months, it should only offer us a temporary multi-month low prior to another crash leg later in 2008 or early in 2009.
Bottom-line is that they must think they’re hedged but as the wheels fall-off, the model is telling us that hedges will fail.  Who knows…maybe solvency and the inability to “honor hedges” will become an important topic as the crash unfolds.

Chart 1

Full report coming soon