More panic, please: Stock market fear gauge suggests a relative lack of concern, and that's often bearish

Investors may be worried about the latest slump in stock prices, but they may not be worried enough.

A key measure of Wall Street’s fear level about the market -- the so-called VIX index -- isn't signaling a high degree of concern at the moment. In the weird way these things often work, the relative lack of concern could be a bad sign -- an indication that the market is more likely to keep falling than to rebound in the short run.

The VIX, or volatility index, is a measure of investors' expectations of near-term volatility in the market. It's calculated based on activity in Standard & Poor's 500 stock index put and call option contracts. Investors and traders use options either to bet on market swings or to hedge against them.

When the VIX falls sharply it signals that many investors and traders believe the stock market has a relatively placid outlook. When it surges higher it says the opposite -- that Wall Street fears that things are going to get much worse for the market.

Of course, any market opinion that attracts a crowd often turns out to be wrong, or too late. So the VIX frequently functions as a great contrarian indicator, at least for short-term traders: Whatever it’s saying, bet the other way.

Take a look at the accompanying chart, which tracks the VIX since the stock market's wild ride began last summer. Since July, each time the VIX spiked above 30 (in August, November, January and March) it foreshadowed that the market sell-off of that moment was cresting, and that a rally (however fleeting) was imminent.

Meanwhile, low points for the VIX since July have signaled near-term market peaks (i.e., good times to sell).

Today the VIX is around 23. That's up from the recent low of 16.30 reached on May 15, but well below the five-year high of 32.24 reached on March 17, the day after brokerage Bear Stearns Cos. collapsed and many stocks were plumbing multiyear lows.

Phil Roth, a veteran chart watcher at Miller, Tabak & Co. in New York, reckons that many investors aren't terribly bearish at the moment because they believe that record oil prices soon will drop, "and that that will be a panacea for the market." The VIX, he figures, in part reflects that hopeful view.

How's that oil bet going? Not so well today: Crude futures in New York were up $2.31 to $137.73 a barrel about 11 a.m. PDT, nearing the record close of $138.54 on June 6.

As for Roth, he sees stocks heading lower -- and expects that the VIX, as usual, will be playing catch-up in the other direction.

Comments

[Edward Harrison]

This isn't the only indicator that spells trouble. There are a bunch of risk indicators from the TED spread to High Yield bond spreads. Market risk is high.

http://www.creditwritedowns.com/2008/06/market-risk-is-high.html