A New $VIX Regime? Or Just the Same Old Thing?

An article appeared at ZeroHedge last week entitled, "Are We in A New VIX Regime?" The article was highlighting research by Goldman Sachs suggesting that the markets have entered into a new period or dynamic, which they called the "great moderation". This article coincided with the $VIX breaking to its lowest weekly close since 2007. I think the gist of the article was that the new low in the $VIX represented a new dynamic that would last a long time. Goldman had identified 7 prior periods where the $VIX wasn't necessarily low but traveled within a certain range. So I guess the break to a new 5 year low represented a new range that should be with us for a long time, and if so, then we should have a complacent market that is rising.

It was the words "new regime" that went off like a light bulb in my head as very often bull or bear markets in any asset will typically start with a close above or below three pivot points. In essence, bull and bear markets are "new regimes" as what used to be no longer exists. So this article got me to thinking about quantifying these breakdowns in the $VIX, so I applied my expertise to the $VIX. How I look at prices and the markets is through pivot points or areas of support and resistance, which are quantfiable. These aren't squishy trendlines drawn by chartists but real points that have shown to be consistent with buying and selling pressure. So I will quantify these "new regimes" in the $VIX; that is, when the $VIX breaks below three pivot points. See figure 1, a weekly chart of the $VIX.

Figure 1. $VIX/ weekly

The red dots are the key pivot points, and you can see the close below those 3 key pivot points as the $VIX broke to a "new regime". Now let's put a chart of the SP500 on the graph, and identify some other new regimes and how price in the SP500 actually fared under these "new regimes" as I have defined them. See figure 2.

Figure 2. $VIX v. SP500/ weekly

As can be seen in the chart, the break below 3 pivots by the $VIX was a "new regime" in 2009 (and the start of a cyclical bull market). However, when the $VIX broke below 3 key pivot points in 2011 and 2012, these were market tops. But let's look at this more critically, and in figure 3, I will construct an indicator that tells us when the $VIX is below 3 key pivot points; the indicator will be at its highest value (see ovals on indicator). The price chart is the SP500 and the $VIX data is hidden.

Figure 3. $VIX v. SP500/ weekly

The indicator shows the "new regime" in 2009, yet when the indicator got to extreme levels of complacency in 2011 and 2012 (twice) by breaking below 3 key pivots, the SP500 tended to top out within several weeks. But several things come out when looking at the data. The $VIX works like most oscillatory indicators. At the start of bull markets, old extremes often give way to a new paradigm. This is your "new regime". As bull markets mature, the $VIX will work like we expect it too. Extremes in fear should be bought and extremes in complacency should be sold. I don't believe the $VIX is forecasting any great moderation, and in the end I think it boils down to the economy and the pace of growth. If you believe that the economy is on the cusp of accelerated growth --like that seen coming off of the 2003 and 2008 market bottoms and like that seen in 1995 after the market had been consolidating for 3 years -- then a new bull market or period of great moderation will make sense. Otherwise, I don't see why this time should be different.

Lastly, I will suggest a good time to sell is when the $VIX actually closes back above the lowest of the most recent 3 key pivot points. If the $VIX closes above 14.19 on a weekly closing basis, then the "great moderation" has likely ended.

Did you know that TheTechnicalTake is now TacticalBeta?

TacticalBeta offers a Free Email Newsletter