Thursday, May 7, 2009

More Of Less Safe After Averages Fall-Tension with Vix Model

Continuing the discussion from this morning's post, the answer to the question "more or less safe" can be made from just looking at the long term chart for the VIX. When I first looked at it in 2007, it was clear that volatility itself would have an impact on my dynamic asset allocation approach to investing.   

This is just the start of an asset allocation analysis, however.  Another question is whether it is "more or less safe" to buy stocks after the S & P average has fallen 56.8%. dshort.com The Vix Model in its current form wants to wait until it becomes more safe to jump back into the market, requiring three months of movement below a reading of 20, the demarcation line for bullish and bearish action under the model.  On the other hand, it is safer to buy when the market has fallen 56.8%, or when the DJIA is at 6500 rather than 14,200, and many blue chip stocks had returned to levels last seen 15 or more years ago.  The VIX model creates a tension at that kind of juncture, reflected in the debate between RB and LB since early March as reflected in these posts. The tension was temporarily relieved by allowing the shift out of short term bonds, where money had been stashed in 2007, back into stocks, and to continue to allow deployment of cash flow from dividends and interest into purchasing common stocks. Since the VIX model has proven its usefulness as a broad brush tool for asset allocation, it is restraining large movements into stocks.   

Part of my approach is tied to my conservative nature and my age. These kind of decisions always have to be adjusted by what I call situational risk, and other matters  unique to each individual investor.

Another point that needs to be highlighted is the movement in the VIX on September 29, 2008 from a worrisome and elevated level of 34.74 to 46.72. More or less safe? What happened?  Good or bad? Would you even need to know the particulars?  LB did not have a name for this phenomenon at the time other than "trouble". It is now called Phase 2 of the Unstable VIX Pattern, an extremely problematic and new phase of a bear market.  It is defined to mean a decisive break in a Phase 1 Unstable VIX Pattern, defined as movement in the VIX between 20 to 30 with occasional spurts into the 30s or even below 20 for short periods. Since LB knew from experience that few stocks would hold their price in a really nasty bear market, the Phase 2 signal was yet another timing indicator to become smaller in stocks. This model, which is just one of many used here at HQ, still requires a thinking person to react, and most importantly to judge whether the signal being sent is still valid or worth following. The model will no longer be a valid model if the market acted in a manner inconsistent with the models fundamental precepts. 

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