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The Speculator
The market's shaken, rattled and ready to
roll
A key
measure of market volatility, the VIX, is shooting up. That means
pessimism is nearing a peak -- and that's a good time to
buy.
By Victor
Niederhoffer and Laurel Kenner
We have been bullish for two weeks now, and the
market has had a fourth and fifth week of declines. Are we giving
up? No.
People forget
that the market can go up when it has been declining for a while,
just as they forget it can fall after a prolonged rise. As everyone
knows, it’s always darkest before the dawn. There is no measure for
“darkest,” of course, but the market has sent a buy signal that’s
the best we have found.
This signal is the Chicago Board
Options Exchange’s Volatility Index, commonly referred to as the VIX
($VIX.X).
The concept is that when VIX is relatively high -- above 30 --
sentiment is unusually pessimistic and prices are down. Because a
high VIX reflects the higher rate of return demanded by investors,
it’s a good time to buy. Conversely, when VIX is relatively low --
below 25 -- sentiment is optimistic and it’s a good time to
sell.
We wrote about our tests of this measure in our May 3,
2001, column, “Make
volatility and uncertainty your friend.” The system’s efficacy
was borne out in subsequent months, when using it would have
resulted in two profitable trades.
In a nutshell, you buy
financial instruments that mimic the movement of the S&P 500
index the first time the VIX closes above 30. You sell when the VIX
closes below 25. Such instruments would include S&P futures
contracts, S&P Depositary Receipts (SPY) or a mutual fund such
as the Vanguard 500 Trust (VFINX).
Volatility hits a
high
Last Thursday, June 20, the VIX closed at 32.5. This
was its first close above 30 since we closed out our last VIX trade
on Nov. 23, 2001.
We have therefore started buying the
market, augmenting our bullish position in the individual stocks we
mentioned buying in our May 13 column (“Foil the
money-snatchers: Buy a stock”).
We have updated the
results of our May 3, 2001, VIX Swing System study with the two
additional trades that came after publication. The table appears
below:
| VIX Swing System |
| Tale of the trades |
|
|
|
|
| Date |
VIX |
Buy S&P 500 |
Sell S&P 500 |
Chg. |
| Oct. 27, 1997 |
39.96 |
876.99 |
|
|
| Dec. 1, 1997 |
24.88 |
|
974.77 |
11.10% |
| Dec. 24, 1997 |
30.47 |
932.7 |
|
|
| Dec. 30, 1997 |
24.93 |
|
970.84 |
4.10% |
| Jan. 9, 1998 |
34.46 |
927.69 |
|
|
| Jan. 14, 1998 |
24.21 |
|
927.94 |
0.00% |
| Aug. 4, 1998 |
33.1 |
1,072.12 |
|
|
| Nov. 5, 1998 |
24.8 |
|
1,133.85 |
5.80% |
| Dec. 14, 1998 |
32.47 |
1,141.20 |
|
|
| Dec. 18, 1998 |
24.66 |
|
1,188.03 |
4.10% |
| Jan. 13, 1999 |
31.26 |
1,234.40 |
|
|
| Mar. 8, 1999 |
24.98 |
|
1,282.73 |
3.90% |
| Sept. 23, 1999 |
30.28 |
1,280.41 |
|
|
| Oct. 6, 1999 |
23.53 |
|
1,325.40 |
3.50% |
| Oct. 15, 1999 |
31.48 |
1,247.41 |
|
|
| Oct. 21, 1999 |
24.77 |
|
1,283.61 |
2.90% |
| Apr. 5, 2000 |
30.59 |
1,487.37 |
|
|
| June 1, 2000 |
24.74 |
|
1,448.81 |
-2.60% |
| Oct. 11, 2000 |
30.95 |
1,364.59 |
|
|
| Jan. 23, 2001 |
23.86 |
|
1,360.00 |
-0.30% |
| Feb. 28, 2001 |
31 |
1239 |
|
|
| May 18, 2001 |
24.26 |
|
1,291.96 |
4.30% |
| Sept. 6, 2001 |
32.48 |
1,103.50 |
|
|
| Nov. 23, 2001 |
24.78 |
|
1,153.00 |
4.50% |
| June 20, 2002 |
32.5 |
1,007.10 |
|
|
| |
| Swing System results |
| 10 out of 12 wins |
| Average Return/Trade |
|
3.40% |
| Standard Deviation |
|
3.40% |
| Total # Trades |
|
12 |
| Total # Trades With Gain |
|
10 | |
When
a patient is very ill, as is the case with the market, it’s wise to
obtain a second and third opinion. And we’ve done that. The second
opinion comes from the Buyback Letter Index, which adds several
bullish percent series together (Investors Intelligence, Consensus
Index, AAII Index and Market Vane as reported in Barron’s) and
averages them. For the last several years, market lows occurred
below readings of 130, while tops came north of 200. The index is
around 127 now.
For our third opinion and last word, we
turned to the one man we trust more than anyone else in the
financial world: Jim Lorie. He was Vic’s doctoral thesis adviser at
the University of Chicago and founded the university’s Center for
Research on Securities Prices, the best database of U.S. stocks. He
sits on many boards and has invested with happy results over several
decades, through boom and bust. He has seen it all, and he passes
along his insights without bombast or pretense. If anyone fits the
definition of a clear thinker, Lorie does. In addition to all these
outstanding qualities, he is a second father to both of
us.
When Vic popped the question about where the market will
go, Lorie answered as follows: “The market will go up like it always
has in the long term. But in the short term, who knows?”
No
one, we’ll venture to say, can do better than that.
Waiting for the new growth
Lorie
recommended Dinesh D’Souza’s "What’s So Great About America" as a
great insightful tome for a rainy day. It’s worth noting that
"Triumph of the Optimists,” the study of world markets in the 20th
century by Elroy Dimson, Paul Marsh and Mike Staunton that we have
cited extensively in our columns over the few months, found that the
highest world returns over the century were achieved by the
countries that most consistently embodied political freedom. We plan
to take D’Souza’s book along with us to read in our spare moments as
we proceed through coming days, and we’re sure that readers will
find it beneficial as well.
Whenever we find ourselves on the
knife’s edge, we find that there is nothing better than a walk
outside in nature. Vic paid a visit to the New York Botanical
Gardens in the Bronx on Saturday, and observed in the conservatory a
big display of lush plants growing on the fallen branch of a dead
tree. The new plants don’t need roots or earth -- just light.
We wonder what the many companies that will grow on the dead
branches of the market are. We are impatient to see them. We don’t
know when they will come -- but we know they will.
At the
time of publication, Victor Niederhoffer and Laurel Kenner owned
none of the securities mentioned in this
column.
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