Friday, March 6, 2020

Just the Vix

In my oft-repeated "Wall of Worry" chart, I've been using the Vix Index divided by the 10-yr Treasury yield as a proxy for the market's level of worry. With 10-yr yields now down to record-setting lows (0.75% as of this writing), putting the 10-yr in the denominator slot makes it the dominant variable. Yields have been pushed to unbelievably low levels because the world is not just pessimistic about the prospects for growth, the world is desperate for a safe-haven hedge against the great unknown which is the Corona virus. The entire Treasury universe has become the most desirable hedge for investors worldwide.

So I'm switching back to just using the Vix index (i.e., the implied volatility of stock index options, which is essentially a measure of how expensive options are). In the past 20 years, stock options have only been more expensive than they are today once, and that was near the end of the 2008 global financial panic.

Chart #1

Chart #1 compares the level of the S&P 500 to the level of the Vix index. The Vix index is a measure of the implied volatility of stock index options. That's a good proxy for the market's level of fear; it's also a measure of how much investors are willing to pay for the safety of options. Owning an option on stocks  is less risky that owning the stocks outright, because the worst that can happen to an option you own is that the option's price can fall to zero—and you lose only what you paid for the option, which in turn is only a fraction of the value of purchasing the underlying stocks.  

It should be clear from this chart that as the Vix index soars, stock prices approach sharply depressed levels. Stock prices then advance as fear subsides (i.e., the market climbs a wall of worry). Peaks in fear coincide with lows in stock prices.

Chart #2

Chart #2 looks at the Vix index going back 20 years. Each vertical bar represents the high, low, and closing value of the Vix index during each month. A value of 50 marks the biggest stock selloffs. The biggest one of them all happened at the end of 2008, when investors feared that global financial markets and global economies were on the verge of collapse. Things aren't likely to get that bad again, we hope, just because of a nasty little virus.

I'm tempted to say that today's Vix value of 50 is probably the high-water mark for the Corona scare. But that temptation is checked by my guess that I'm not the only one to make this observation. There's lots of money available to buy today's "dip." The bottom will occur when "buying the dip" becomes almost intolerably scary.

Chart #3

As Chart #3 shows, credit risk fears (using credit default swap spreads as a proxy for corporate credit risk) have indeed jumped, but they are still short of true panic levels.

Chart #4

As Chart #4 shows, 2-yr swap spreads have also jumped, but not by very much. Systemic financial risk is still relatively low and there is still plenty of liquidity in the system. Central banks are working hard to accommodate the market's desire for safety and liquidity. The global economy may be at great risk of a recession, but, unlike 2008, global financial markets are still relatively healthy.

Back near the end of 2008 it was hard to imagine how the world would avoid collapse and "the end of the world as we know it." Today it's not very hard to imagine how the world can avoid a global pandemic: all it takes is the development of a vaccine and/or therapeutic drugs. And work to that end is already well underway.

UPDATE: after hours, March 6th: Dramatic change just prior to the close today, with the Vix index plunging and stock prices soaring. Just prior to the reversal, the Vix index had surged to 54 (only to subsequently decline to 42), and that was enough to encourage bottom-fishing and buy-the-dippers. Maybe we have seen peak panic.

Chart #5

Chart #6

Note that Chart #6 reflects the intra-day high of the Vix, whereas Chart #5 shows the closing level of the Vix.


DownSouth said...

Thanks for your voice of calm among all of the breathless shouting!

A friend in China called to chat today. He said his best message for America was turn off the news and quit the unfounded panicking.

Have a great weekend.

Fred said...

This reminds me of 2009 when I was searching in vain for any positive explanation for what was going on in the financial markets and found your site. It really helped me gain some perspective on the crisis and I once again appreciate your thoughtful analysis. I'm hoping that we will all pull together to work through this and brighter days will be ahead despite the gloomy predictions. I sometimes wonder how this generation would have handled 2 World Wars, the Great Depression and the Cuban Missile Crisis! God bless us all.

Benjamin Cole said...

Kudos to Grannis, again.

If you have a cast-iron stomach matched by nerves of steel, this looks like a buying opportunity. Some travel-industry issues are down 25% or more. Long-run, travel is a growth industry. You will not be buying at the top. Remember, when they are dancing in the streets, sell. When gloom-and-doom pervades, buy.

Sooner or later, the coronavirus will pass, and I think it is relatively harmless to ordinary healthy non-elderly adults. (Children seem immune too, thanks goodness. )

Good luck everybody!

Johnny Bee Dawg said...

Last Friday's low just below 2900 has held, and now the VIX has finally retreated, coincident with rumors of coming Fed actions at end of day. 2900 has proved to be an excellent Buy point, so far.

Markets dont necessarily need to wait for a treatment or vaccine to bottom, IMO.
Imagine if the Fed lowered the Fed Funds rate to match the 10 year yield.
Imagine if markets started noticing the 57,000+ people who have completely recovered, and show no more signs of infection. The mainstream media has completely ignored this.
Imagine if markets noticed that "Active cases" have shrunk to 41309 as I write this. Down from over 44000 last week. Also ignored by media.

Harry said...

Between the technical analyses provided by Scott and the blunt, in-your-chops commentary provided by Nick Murray, I continually find calm and smarts in their comments. When all the world is doom and gloom, I am always reminded by these two of reality. It's not so that I need it as much as my clients need it--Scott, Nick, thanks for your service to all who work hard to do the right thing for our clients and for our families.

Stowbrod said...

Thanks Scott for your usual evidence based, measured analysis. I'm a physician which gives me some limited advantage in understanding this novel threat. I can add a few observations. The battle against the COVID virus is just beginning now, despite all the preparation while the virus spread in China the reality of people dying in American ICU's has mobilized the medical community intellectually and physically. It has propelled the US into an international leadership role but has also focused the ingenuity of the entire world on the virus. Both treatment and isolation techniques are rapidly improving. There are several ways in which influenza is more threatening than the COVID, most importantly Corona seems to spare children and adolescents, that is huge. And it is relatively easy on those under 65 who constitute the bulk of the labor force. The incidence of COVID in Asia and the West has yet to peak and the numbers may artifactual get much worse due to the simple availability of testing. But the rapid availability of close to real time testing is what is needed to squash this threat. Of course for more dysfunctional societies, like Iran or North Korea, their suffering will be worse. Hopefully they will be receptive to outside help.

Robert said...

Thank you for the analysis. If I may (humbly) add.. Only twice, since inception, RSI VIX was higher. In the 1997 scare peaking at 72.94 and in 08, peaking at 79.23. As of Friday's close, RSI was at 72.43. All on a monthly basis so Friday's reading can/may change in the coming weeks.

More importantly, after peaking -in all cases- stocks trades lower for 4 to 8 weeks. So participants do get burned on these bouts and are slow to return. Plus the effects of forced liquidations, margin calls and reconstitution/rotation of portfolios.

Christophe said...

This could be black swan event. I am all cash/TLT/GLD since 2/25 (was raising cash level since months as market was melting up). The last time, I was all cash was mostly too late in 08/09. I also found Scott, soon after, and he has been the reason why I have been so bullish since then. A sincere thank you Scott!

We will most likely take full Covid-19 consequences or have to experience full quarantine.

Here are likely facts about Covid-19:
Death rate: ~0.8% (x8 a strong flu) Official WHO number is 3.4%
Attack/Contamination rate: 50%+ (x4 flu. flu is a low 12%). Could be near 100% (x9 the flu) if we do not quarantine.
Rate of emergency care needed (respirators...): ??? Flu is 0.05% ( Covid-19 could be 1% to 10% or x20 to x200 flu)

Total-Fatalities = x32 flu in base scenario (death-rate 0.8%). If 100% attack-rate = x57 flu

Even at a death rate like the Flu. Since we get a contamination rate a lot higher (100%?) just to avoid the consequences of a medical system completely overwhelmed we might have to quarantine the entire country, like we see happening in the world.

We can all guess the consequences of such a scenario. It is not pretty, especially with the markets still near 3000. There is so much room to fall.


The Cliff Claven of Finance said...

I'd like to thank Mr. Grannis for the VIX chart.

When I realized how high VIX was, I decided to bet on a return to an average VIX some day.

I bought SVXY at 37.24 on Monday morning March 9.

Would have had a better price if I woke up earlier !

My portfolio started the year at 85% cash and was 100% cash since February 24.

This is my first new investment of 2020.

I've been investing since the mid-1970s and do not recall any correction or bear market related to the flu.

Far more people die from other varieties of the flu every year, but stock investors never cared about that !

Starting in the spring, no one thinks about the flu until the weather gets cold again near the end of the year.