Think of the VIX as a canary in a coal mine. When the canary drops dead, the individual investor needs to react.
The canary has dropped dead in two situations. The Vix moves out of the Stable Vix Pattern into an Unstable Vix Pattern, characterized by a Whipsaw Pattern of movement between 20 and 30 in the VIX, with short spurts above 30 and falls below 20, coming out of a long stable period of continuous movement below 20 which is the Stable VIX Pattern. The canary has also dropped dead, actually a whole colony has kicked the bucket, if the VIX ever moves again in a decisive manner out the 20 to 30 pattern, now called Phase 1 of the Unstable VIX Pattern, and bursts well into the 40s after establishing a long period of movement in the Phase 1 period of the Unstable VIX Pattern. The movement on 9/29/2008 marked the end of Phase 1 of that pattern in effect since August 2007. The Model dates the bear market under its criteria as starting in August 2007 with the formation of the Unstable VIX Pattern.
The Model itself says nothing about what each individual needs to do once there is a Trigger Event, defined to mean a decisive breakdown in a Stable VIX Pattern of VIX movement between 10 to 20, with the VIX moving close to 30. The Trigger Event is the start of the Unstable Pattern. It is saying that stocks have become riskier as an asset class, even more riskier than professional investors might then realize. With that enhanced risk, I suggest comes a need for individuals to shift their asset allocation mix by reducing exposure to stocks.
The VIX Chart from 2007 shows a series of these Trigger Events tied to the worsening credit problems in the U.S. VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern In each case, after the canary died, the market rallied, the VIX fell, and there was an opportunity to lighten up stock positions. In fact, the first move back to below 20 after the August 2007 Trigger Event happened in early October 2007 when the DJIA was over 14,000. This may or may not occur again. It has occurred in the past. It happened in 1987, using the model developed for the VIX and applying it to the volatility data for the S & P 100.
A Trigger Event occurred in April 1987, followed by a period where the market made a counter-move back up, with the volatility index falling below 20 again. Then, shortly thereafter, there was the Crash of October 1987. Similar Trigger Events occurred in 1997 and 1998. The period in 1999 is called a Non-Confirmation Event, that is, the parabolic move up in the averages was not confirmed by the movement of the VIX in the 20s, so the Model said sell that sucker. A brief fall below 20 on the VIX came in August 2000, the last chance to lighten up.
A Trigger Event occurred in April 1987, followed by a period where the market made a counter-move back up, with the volatility index falling below 20 again. Then, shortly thereafter, there was the Crash of October 1987. Similar Trigger Events occurred in 1997 and 1998. The period in 1999 is called a Non-Confirmation Event, that is, the parabolic move up in the averages was not confirmed by the movement of the VIX in the 20s, so the Model said sell that sucker. A brief fall below 20 on the VIX came in August 2000, the last chance to lighten up.
The Model also gives a green light signal when the VIX moves out of the Unstable Pattern back into a continuous movement below 20 and those signals were given coming out of the bear market in 1990-1991 and 2001-2002. This post shows charts of a Stable VIX Pattern from 2004 to 2006. Vix Charts from 2004 2005 2006 Stable VIX Patterns Phase 1 and Phase 2 I could look at that chart now and say that is an investable bull market in stocks. Just look at the flat line in late 2006 and early 2007, just before the major Alert in February 2007.
I am just writing this from memory and in my normal stream of consciousness, so the reader needs to check all of this by reading all of my posts on this subject which are linked in this Gateway Post: USING THE VIX MODEL AS A TIMING INDICATOR FOR LONGER TERM STOCK ALLOCATIONS
It helps to have some charts ready to check everything yourself. Always check and verify everything.
The key point has to be that Volatility is an important tool in the individuals decision making process on stock allocation. The amount of a shift out of stocks upon the formation of an Unstable Pattern out of the Stable Pattern is up to each individual and the Model is flexible in that regard. When the Vix Model was integrated into the tools used in my Dynamic Asset Allocation approach, the Model would simply suggest moving more out of stocks as an individual's situational risk increases.
Even those investors with no situational risks might want to raise some capital by selling stocks simply to reinvest at better prices. I am still sitting on 30% of my investable assets in cash. I have only made one significant move by selling some short term bonds in February and early March to buy primarily consumer staple stocks. My personal model also allows me now to invest cash flow from dividends and interests.
Since I am conservative by nature, my personalized version of the Model restrains large movements back into stocks until the VIX falls below 20 and stays there for 3 months. My model also allows for reinvestment of dividends during the Unstable VIX phase, and the purchase of stock with proceeds from the sale of another. The VIX model has no impact on the purchasing of bonds or bond like investments. Readers of this blog are familiar with considerable activity in those asset classes. The VIX model only applies to my allocation to stocks, and nothing else.
Even those investors with no situational risks might want to raise some capital by selling stocks simply to reinvest at better prices. I am still sitting on 30% of my investable assets in cash. I have only made one significant move by selling some short term bonds in February and early March to buy primarily consumer staple stocks. My personal model also allows me now to invest cash flow from dividends and interests.
Since I am conservative by nature, my personalized version of the Model restrains large movements back into stocks until the VIX falls below 20 and stays there for 3 months. My model also allows for reinvestment of dividends during the Unstable VIX phase, and the purchase of stock with proceeds from the sale of another. The VIX model has no impact on the purchasing of bonds or bond like investments. Readers of this blog are familiar with considerable activity in those asset classes. The VIX model only applies to my allocation to stocks, and nothing else.
Situational risks include any risk unique to the individual where a prolonged fall in stock prices would be a significant disruptive event, usually due to some need for the funds within five or less years.
Two other lines of discussion are also important. The first is my posts that are criticisms of Professor Siegel's Stocks for the Long Term thesis. My argument is that the time periods need to be broken down into much shorter increments. I would agree with him that stocks are likely to outperform a ten year treasury bond over the next ten years. But that says nothing about what to do if stocks double in the next five years and the 10 year treasury rises from 3 to 8%. To Professor Siegel: Time for a Re-Think
I am not a professor. but just an individual investor.
We have to live in the real world with significant situational risks for each of us. My other line of topics is what I call Dynamic Asset Allocation, an approach that requires a shift in the mix of assets based on events unconnected with the needs of the individual investor based on what is happening in the market.
The Vix Asset Allocation Model is just one part of Dynamic Asset Allocation. Those shifts are not short term shifts, for the most part, but shifts in the mix that may last several years. That model incorporates elements of static asset allocation theory which changes the mix based on an individual's age (more bonds as your grow older) and other matters unique to each individual, and would include for example periodic rebalancing.
I am not a professor. but just an individual investor.
We have to live in the real world with significant situational risks for each of us. My other line of topics is what I call Dynamic Asset Allocation, an approach that requires a shift in the mix of assets based on events unconnected with the needs of the individual investor based on what is happening in the market.
The Vix Asset Allocation Model is just one part of Dynamic Asset Allocation. Those shifts are not short term shifts, for the most part, but shifts in the mix that may last several years. That model incorporates elements of static asset allocation theory which changes the mix based on an individual's age (more bonds as your grow older) and other matters unique to each individual, and would include for example periodic rebalancing.
Added 9:37 P. M : In response to a question, my current assessment is as follows. Given the severity of the disruptive pattern, similar to that shown after the 1987 crash in the ^VXO and ^VXN during the Nasdaq crash 2000-2002, people need a year to recover from the shock. The shock event for the VIX, which took it out of a normal bear market happened with the commencement of the Phase 2 Unstable VIX pattern shortly after Lehman's failure. NYTimes.com
I would give it a year from that disruptive event, maybe longer due to the severity of this last event. Calm and confidence need to be restored. The VIX is still Unstable as defined under the Model. I would expect the VIX to gradually find its way down into a range bound movement in the 20 to 30 range before tip toeing back to below 20. I would expect that a failure to find stability in the 20 to 30 range would indicate continued whipsaw movement in an overall dominant secular bear market pattern in effect since 2000. Once stability is found in the 20 to 30 range, then movement may continue down into Phase 1 of the Stable Bull Market Pattern. I did anticipate that the VXD would be the first to cross the 30 barrier after the Catastrophic Event in September 2008 under the Vix Model.
I would give it a year from that disruptive event, maybe longer due to the severity of this last event. Calm and confidence need to be restored. The VIX is still Unstable as defined under the Model. I would expect the VIX to gradually find its way down into a range bound movement in the 20 to 30 range before tip toeing back to below 20. I would expect that a failure to find stability in the 20 to 30 range would indicate continued whipsaw movement in an overall dominant secular bear market pattern in effect since 2000. Once stability is found in the 20 to 30 range, then movement may continue down into Phase 1 of the Stable Bull Market Pattern. I did anticipate that the VXD would be the first to cross the 30 barrier after the Catastrophic Event in September 2008 under the Vix Model.
This is a link to the historical prices for ^vxo before the 1987 crash. The Trigger Event was in Apri l^VXO: Historical Prices
(just scroll back in time starting in December 1987 to the start, and you will see)
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