Thursday, October 22, 2009

Is VIX 20 Important?

Much ado has been made lately about the market's fear index, the VIX, arriving at 20 - as low as it's been since the start of the credit debacle and way down from the end-of-the-world 80 it was at just a year ago. But it's just another round number like Dow 10000, so should we care? Well, yes. If you look at how fear has traversed this market, you see something significant: (click to enlarge charts)

The 20 level has served as a ceiling for improving emotions all during this debt-induced mess. In fact, you can look at a VIX chart covering the entire debt balloon era that got under way in the late 80s, and see the significance of this 20 level:

It is a line in the sand dividing the nice, stable bull move years, shown in green, and the nasty, gyrating topping actions and bear move years, shown in red. At the left, we had the '90 recession, then a quick and painless trip back into the green. As the debt balloon grew, we ran into the savings and loan crisis of the 90s and the dot-bomb top and bear market and a much bigger sea of red. But we got back to the nice green for a little while. Then, the next debt complication, the housing bust, sends us hurdling back into the red. Now we are back at the dividing line. Are we going to emerge back into the calm green seas or see a spreading sea of red? There is a pattern in the progression of fear as our debt level goes parabolic - the fear spikes go higher and the seas of red grow bigger. Unless we can now break and hold the sub-20 territory and defeat this progressing pattern, we may be at a very dangerous turn point in the stock market.

There is a confluence of projections from very independent means of analysis (fundamental, technical, sentiment, fractal, web bot) that all agree on this impending turn point condition. From technical analysis, we have a rising wedge formation:

This is a strong bearish formation and is the inverse of a falling wedge that can be seen in this year's VIX chart above.

And from Planet Yelnick, an Elliott Wave site, we have:
By far the most interesting discussion in the STU was around the banking index, which shows a fairly clear top. This would be huge as the bank stocks have been like the Nifty Fifty, or in this case the High Five: a small number of stocks = a major part of the rise. This sort of situation is bearish: a bull market runs up on a broadening base while a bear rally runs out of steam on a narrowing base. Their sudden weakness presages more than a drop in the Dow; it signals a return of the credit crisis.
A return of the credit crisis? Egad! Back into the sea of red we go. Loans are, in fact, hard to get. Farmers can't get loans, which is making things difficult for companies like Deere. This could aggravate food shortages and prices. But this could be the least of our problems if we don't see the bankers starting to help main street more.

The popular bears' argument about the huge debt overhang and dollar problem is well known. But did you know that two of the biggest table thumpers for a glorious new bull climb have recently moved to the edge of the bears' camp on this issue? On CNBC's Mad Money, Jim Cramer was confronted with a viewer's question asking him if the parabolic debt explosion worried him. His instant, impassioned response was yes, it worries him and, unless it is immediately dealt with successfully, it will cause a new bear market within 18 months. And Larry Kudlow has recently started to proclaim that he is a "short term" bull but he sees the dollar debasement changing things out about 3 months. That's probably the two head cheerleaders for team Dow going over to the other side, only disagreeing on when. I don't feel cheered.

Is there any hope? Yes. We can do what Ross Perot tried to explain to the American people back in 1992 in his presidential campaign. If we had reformed our government the way his Reform Party tried to, we would be living in a much different world today. It would have been relatively painless back then at the left end of the VIX chart above. But now it is a scary time indeed.

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