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Bristlecone Monthly News Digest
Greetings!
"Volatility is a symptom that people have no idea of the underlying value"
-- Jeremy Grantham
"There are two times in a man's life when he should not speculate-when he can't afford it, and when he can."
-- Mark Twain
A Primer on Volatility
One of the more commonly-quoted measures of investor sentiment is the Chicago Board Options Exchange Volatility Index, often referred to by its trading ticker, VIX. In essence, the VIX is a composite of investors' expectations for near-term (30 day) volatility on the S&P 500 stock index. It is derived from the implied volatility on actual S&P 500 index options contracts traded on the Chicago Options Exchange. The VIX is often referred to as an "investor fear gauge" because it tends to increase during periods of heightened uncertainty, when investors' expectations for future stock price movements are the most divergent.
As you can see from the chart below, expectations for market volatility spiked dramatically after the bankruptcy of Lehman Brothers on Sep 15, 2008, with the VIX eventually closing at an all-time high of 80.86 on 11/20/08. Subsequently, the index steadily declined as the U.S. financial system pulled back from the brink of collapse and investor fear receded. By the end of April, 2010, the VIX was hovering in the mid-teens. The "flash crash" of May 6 and subsequent fears of a European sovereign debt crisis caused a brief resurgence in the index, to a closing value of 45.79 on May 20. Today, the VIX trades at around 25. To give this number some additional context, the average daily value for the VIX index since its inception in 1991 is about 21. The all-time low is just over 9, and the trough leading up to the 2008 financial crisis was a close of 9.89 on 1/24/07. 
While the VIX has limited predictive value, it does give us some useful context for investor sentiment. Generally speaking, a reading below the mid 20s indicates that investors are relatively sanguine in their attitudes toward risk, while readings on the high end of the historical range tend to occur during market shocks or corrections. One limitation of the VIX is that it frames risk solely in terms of expected standard deviation of stock prices, which as we've previously noted is not the only (or best) way to define risk. Indeed, volatility is often a friend to the value investor, as indicated by the fact that the peak value of the VIX index in late 2008 occurred very near a 13 year low on the S&P 500 Index (a generational buying opportunity). Moreover, elevated levels in the VIX have historically been a poor leading indicator of market decline. More often than not, investor fear is aroused only after a market correction has begun-not prior to it. A close study of the VIX points to the wisdom in Warren Buffett's maxim: "Be greedy when others are fearful, and fearful when others are greedy." |
Reflection on the Sovereign Debt Crisis
July 2010 - Edward Chancellor, GMO
In the context of many worst-case scenarios being bandied about regarding European sovereign debt, this white paper from GMO offers a thorough historical analysis of when, why, and how governments have defaulted on their debt obligations in the past (note: free registration required to access GMO research). >> Read the Article |
So That's Why Investors Can't Think for Themselves
June 19, 2010 - Wall Street Journal
Jason Zweig reports on the emerging field of "neuro-economics", explaining how a "herd mentality" is hard-wired in our evolutionary brains-and how this physiology can interfere with our ability to make sound investing decisions. >> Read the Article |
The Miracle Deficit Cure? Growth
July 13, 2010 - Slate
Slate's resident financial columnist, Daniel Gross, explains why reported estimates of the federal budget deficit are so volatile, and why recent data points to an encouraging trend of deficit-mitigation through economic growth. >> Read the Article
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