Friday, November 21, 2008

Notable NEWS: C, DK, NYT/Further Discussion of Volatility and Asset Allocation

Delek experienced an explosion and fire at it refinery in Tyler, Texas, injuring at least 6 people.  I intend to hold onto my 100 shares for at least 11 months before selling for a loss.  I may now sell for a gain at any time.

To further highlight the difficulties in the newspaper business, the New York Times slashed its dividend from $.23 to $.06. 

I thought that the story in the WSJ that Citigroup was considering auctioning itself in parts to be an act of desperation.  MarketWatch Really, who would consider doing that in this kind of market with prices depressed for just about everything other than U.S. treasuries unless the end was near?.

To further my discussion about the VIX, several people have noted that a prolonged period of a low and stable VIX will often breed complacency, which in itself will cause increased speculation and risk taking that may ultimately germinate the seeds necessary for the blooming of the next bear market.  See, generally, Seeking Alpha The more dangerous phase of complacency and speculation will likely be indicated by a long VIX pattern in the 10 to 15 range, which is what I call the second phase of a stable bull  market pattern.  Emerging markets might take off big time during this phase.  I have circulated to some a fifty page book that describes some of these theories and models in boring and excruciating detail.  Some have said it makes for good bedtime reading. I am not going into that kind of detail in this blog.  But I did want to include an excerpt from my prior discussion of the DJIA volatility index, VXD .^VXD: Summary for CBOE DJIA VOLATILITY INDEX 

"One of the main differences noted between the VXD and the VIX is that the VXD shows a longer and more stable bull 2 pattern in the 10 to 15 range, which suggests that the components of the DJIA were considered to be safer than the S & P 500 stocks by the market participants, as shown by the lower volatility numbers.  The VXD shows a very stable bull pattern from the commencement of the chart until July 27, 2007 when the VXD suddenly closed above 20 at 22.42 from 16 a couple of days earlier.  This kind of variation should provide an investor with a serious wake up call. The VXD is the most stable of all of the  volatility charts. A variation from 16 to 22.42 would at a minimum require constant monitoring for the next several days even if there was no confirmation from any other indicator like the VIX. Between late-July to mid-August 2007, the VXD stayed above 20 and started to rise to a range bound mid-20 range by mid-August. For 2 ½ years the VXD did not have a close above 20 and now it was closing in the mid- 20s everyday. This was the most profound warning of any volatility index because it had already shown itself to be the most stable. A warning of this kind from RVX would mean little since it could range up to this level even in a bull market. The VIX would be unstable in this range but it would not be flashing a warning with red bells and whistles at 23 or 24. This pattern for the VXD is considered serious enough to constitute a clear warning to change one’s asset allocation. So, even without the VIX reading which was confirming trouble ahead, this spike in VXD from almost 10 to 25 in a few days would also start the clock counting on a forced reduction in stocks as soon as the VXD returned to a lower reading in the 16 to 18 range which it soon did as shown in a bar chart from late September to early October 2007, when the Dow ultimately surpassed 14,000 (bar chart from book not included here) 

Please focus first on the huge variation in VXD chart between the high and low on September 18, 2007. This is just a mind bender for the VXD. The high was 26.62 and the low was 13.17 and the close was 18.53. If you did not hear the message before, then this one was hard to overlook. This would give you plenty of time to reduce the stock exposure at higher levels in the late September or early October 2007. The next unmistakable warning would come in just a few days as the VXD quickly fell out of the 15 to 20 range and back into its unstable range as shown in the bar chart  for November. By November, every volatility indicator is signaling big trouble."   

The volatility indexes for the Russell 2000 and the Nasdaq require a separate analysis. 

While my volatility models did provide warnings about the bear market starting in October 2007, as well as the prior bear market, and it required a forced stock reduction in early October 2007 when the VIX fell from over 30 in August to less than 18, it did not and could not predict the severity of the bear market that was to come. While the VIX has given warnings during what I call the Transition Phase from bull to bear, to enable a change in asset allocation at the highest plateau of prices, there is no guarantee that it will do so again. There was nothing in the model, for example, that forecasted a spike in the VIX starting in early October 2008 way above its prior highs during the last bear market. I have been trying to put a label on what that means and my working theory, and this is all theory, is set forth in my last post.