This is a republication of a 10/17/2014 post that I published at Seekingalpha. Vix Asset Allocation Model | Seeking Alpha I formulated this Model in early 2007 after looking for the first time at a VIX chart.
The last Stable Vix Pattern started to form in March 2023.
All links to SA posts no longer work including the one above. The link will only take you to my SA page rather than the linked post.
Since the VIX may soon form a Trigger Event, I decided to republish that old post here verbatim.
CBOE Volatility Index (^VIX) - Yahoo Finance
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For several years now, I am been writing posts explaining my Vix Asset Allocation Model. I thought that it would be helpful to summarize that Model in an Instablog Post here at SeekingAlpha. I will be summarizing more lengthy discussions contained in my blog, with some liberal drag and drops mostly from the following posts.
Vix Asset Allocation Model Explained Simply
Use of the VIX as a Timing Model
VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern-August 2007 Trigger Event
VIX and S & P Compared 1990 to 1997
Vix Charts from 2004 2005 2006 Stable VIX Patterns Phase 1 and Phase 2
This model is based on historical patterns and is obvious once an investor opens a long term VIX Chart and knows the stock market history between 1990 and now: VOLATILITY S&P 500 Index Chart
There are two Main Patterns:
1. Stable Vix Pattern: Continuous Movement in the Vix below 20, an investable bull market in stocks.
2. Unstable Vix Pattern: A Whipsaw Pattern Movement in the VIX at levels above 20, a far more riskier market for the individual investor, most likely what most people would call a bear market, or a Transition Phase from a bull to a bear market.
Each Main Pattern is divided into Two Phases:
Phase 1 STABLE VIX PATTERN: Mostly moving in a range from 15 to 20
Phase 2 STABLE VIX PATTERN: Mostly moving in a range of 10 to 15
Phase 1 Unstable Vix Pattern: Whipsaw Movement in the VIX mostly in the 20 to 30 range with temporary movements below 20 and above 30, mostly descriptive of an ongoing bear market with periodic rallies, and also descriptive of a Transition Phase from Bull to Bear.
Phase 2 Unstable Vix Pattern: Catastrophic Bear Market marked by a decisive break in a Phase 1 movement by a major burst into the 40s followed by even more elevated levels in the VIX.
Alert: An "Alert" happens when either an unusual break in a pre-existing pattern occurs, or there is some meandering by the VIX above a level considered to be significant under the model, without a decisive break into a bull or bear pattern characteristic of the Transition Phase or an unstable VIX pattern. An example of an alert is the decisive break in the Phase 2 bull market pattern in the VIX in 2/07. (see typical story from February 2007. The break was not a trigger event since the pattern broken was a stable bull market pattern Phase 2, and the Phase 1 pattern was still stable. An alert, however, should cause an investor to learn everything possible about the external events causing the alerts and to be considering possible major changes in asset allocation.
A Trigger Event Ushers in the Unstable Vix Pattern: A "Trigger" is a decisive break in the stable bull market pattern by a spike in volatility clearly outside the range tolerable for a Stable VIX pattern. Those spikes happened in two stages in 2007, in August and November. The trigger event requires a change in exposure to stocks. Timing of that change can vary, but LB (my Left Brain) has noted under all models covering the entire time period for which there is a volatility index that there would have been at least one, usually two, counter-moves back to below 20 that would be accompanied by a rise in the market average. This would afford an opportunity to lighten up at better prices than prevalent during the TRIGGER EVENT Phase. While this opportunity has happened in the past, there is certainly no guarantee that it will happen after the next Trigger Event or any other ones in the future.
Trigger Events:
April 1987 based on volatility index for the S & P 100 (VIX data starts in 1990): Parallels to VXO 1987-1988
October 1997: More on VIX AND ASSET ALLOCATION
August 2007: VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern
There have been three prior Trigger Events (data from Yahoo Finance):
1987 Trigger Event (based on volatility for S & P 100-VXO-VIX Data Starts in 1990)
October 1997 Trigger Event (not resolved until later part of 2003, confirmed in October 1998)
The Unstable VIX Pattern is what happens after the Trigger Event. This pattern will be a dangerous and difficult market for the individual to navigate. There will generally be a lot of volatile up and down movement in stocks, with the end result being a long period of going nowhere. Going nowhere on a roller coaster is also the hallmark characteristic of a long term bear market, where the buy and hold investor in an S & P 500 Index would likely lose principal after adjusting for inflation even with dividends reinvested. I started to invest in the late 1960s. The annualized total return (dividends reinvested) of the S & P 500 from January 1966 through July 1982 was -1.813% Adjusted for Inflation and before taxes. That is an annualized loss. Dividends back then were taxed at the highest marginal ordinary income rate.
The long term bear market can last for 15 or more years. The Vix Model is a shorter term signal and its signals can be given in long term structural bull and bear markets.
Phase 1 of the Unstable VIX Pattern will be market by repetitive movement in the VIX between 20 to 30, with temporary spurts to over 30 and below 20. A potentially more ominous pattern, Phase 2, would be a burst into the 40s that could lead to even further elevation into the 50s and beyond, which would be associated with catastrophic stock market losses similar to what happened after the Lehman failure in September 2008. There was a Phase 2 formation in late September 2008 that gave investors two days warning to get out. SEPTEMBER 2008: FORMATION OF THE DEADLY PHASE 2 OF THE UNSTABLE VIX PATTERN The operative word after a Phase 2 signal is caution.
The Unstable VIX Pattern, Phases 1 and 2, can last for a very long time. The one decision investor could just sit it out in five year treasury notes, rolling them over if necessary, and save themselves a lot of heartburn. Historically, it would be difficult for a skilled trader to navigate the Unstable VIX Pattern to beat the return of a five year treasury note.
The more adventuresome investor, such as myself, will play the volatility with the substantial cash raised after the First Trigger Event. Generally, this will be a mechanical trading strategy. During Phase 1, stocks are sold when the VIX moves below 20 and hedges are bought for the stocks that are kept.
When the VIX spikes toward 30 or over, stocks are bought again and the hedges are sold. This will work until Phase 2 comes around which may never happen. It did happen in September 2008. Then the investor following this path, which included me, would likely have no hedges, having sold them when the VIX spiked to the low 30s or high 20s, and would have added some stock positions back. Then, an adjustment has to be made when it becomes apparent that a Phase 2 of the Unstable VIX Pattern has formed, with the recognition that danger lurks at ever corner.
If I bought good companies when their price had fallen to reasonable levels for a long term holder, I can become a long term holder, start reinvesting the dividends, and potentially buy more shares during this catastrophic phase of the Unstable Vix Pattern with the cash stash. I could then wait for the movement to below 20 in the VIX and then decide what to do with the position added just prior to the Phase 2, Unstable VIX Pattern formation coming out of a long standing Phase 1 pattern. Trading and Asset Allocation in Stable and Unstable VIX Pattern; More on VIX AND ASSET ALLOCATION; Stable and Unstable VIX Patterns Impacting Changes in Allocation to Stocks, Bonds and Cash (November 2008 Post). In the case of my PEP shares, I was able to sell those shares before a significant price drop and then buy them back after the price fell over $20. Volatility, Catastrophic Event Formation, Asset Allocation Decision for Pepsi September 2008
When the catastrophic event formation occurred in September 2008, the Phase 1 Unstable Pattern had been in force since August 2007, and I could trade that pattern based on the movement in the VIX until Phase 2 emerged, and then there is no guidance from the model. The crap has hit the fan.
As shown in great detail in this blog, I carefully deployed cash flow to buy mostly income producing stocks that appeared to present good values during the September 2008 to March 2009 period, and this worked out just fine. It may not the next time. The Great Depression Part Two was avoided by the efforts of governments around the world.
Green Light: During an Unstable VIX Pattern, the VIX will periodically move below 20. A Stable VIX Pattern is not formed until there is continuous movement in the VIX below 20 for 3 months. Some minor movement above 20 is allowed without restarting the count.
Green Light Signals:
May 1991 and Terminated by Trigger Event October 1997: VIX and S & P Compared 1990 to 1997
January 2004 and Terminated by Trigger Event August 2007: More on VIX AND ASSET ALLOCATION
September 2012 - Stable Vix Pattern as of 9/26/12
Disclaimer: I am not a financial advisor, but simply an individual investor who has been managing my own money since I was a teenager. In this post, I am acting solely as a financial journalist focusing on my own investments. The information contained in this post is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sale of securities. Nothing in this post is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. A failure to perform due diligence only increases what I call "error creep". Stocks, Bonds & Politics: ERROR CREEP and the INVESTING PROCESS Each investor needs to assess a potential investment taking into account their personal risk tolerances, goals, and situational risks. I can only make that kind of assessment for myself and my family members.
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