With the S&P 500 closing a hair under 1,912 points and setting a blistering record (at least on paper), is it now time to stop the worrying and enjoy what has been a disconcerting but nonetheless stable ride? After all, experts have reiterated that the markets are flooded with cheap liquidity (thank you, Mr. Bernanke...) and that the core financial institutions are more cash-rich than they were just prior to the 2008 collapse.
Unlike previous moments when equities hovered around peak thresholds, there is still a respectable number of bearish prognosticators producing all manners of arguments as to why the current situation in the markets is unsustainable. The most recent offering is speculation towards a volatility reversal, or a switch in sentiment for the CBOE S&P 500 Volatility Index, best known as the "VIX."
This volatility indicator is often cited by mainstream analysts and financial journalists who truth be told, probably have little understanding of the math that indirectly results in simplified summaries that are too general for scientific research but fits perfectly within media soundbytes and the "corporatocracy" that sponsors the networks.
Right now, the VIX is trading under 10, a "low" number that suggests market participants are complacent and that valuations may be reaching a top. On the other hand, a "high" number such as 25, a target "achieved" in May of 2012, suggests extreme fear. Contrarians use this indicator to perform the opposite action that is undertaken by the masses (oh, those foolish masses!)...because you know...you're supposed to be greedy when others are fearful and be fearful when others are blah, blah, blah...
Taken literally, the VIX is telling you to sell : just like in retail psychology, it doesn't make sense to buy items at inflated prices. While the stock market is obviously different from a retail market in the sense that yes, sometimes the items on Wall Street can reach higher plateaus, seemingly never to come back down again, nothing takes a straight turn up indefinitely. Even the best names need a break from rampant speculation. And thus, as a contrarian, this is a perfect opportunity to take profits from the table.
I agree with the ultimate conclusion that the risk assessment does not favor doubling down on new positions at this immediate juncture but don't let my alignment with an opinionated result confuse how I got to this point.
I could care less what the VIX says : at the root, it is another tracking mechanism of an index's price history that is used to predict future volatility of the stock market. To me, it sounds like a fancier version of the simple moving average, the holy grail of some technical analysts but at the end of the day, it's just an average. It's not that mathematical models don't have their place in finance : they clearly do and I champion their usage!
But this comes with an important caveat : the methodology has to be appropriate for the madness. I wouldn't take a straight edge to measure the surface area of an inflated balloon but for reasons yet unknown, many financial analysts continue to employ pseudo-science as their definitive measure for determining risk and reward.
Does that sound crazy? I hope so...because that's what a sole reliance on the VIX (or any other indicator) amounts to.