Friday, May 4, 2007

Predictive Value of SPX and VIX Correlation – First Pass

Before the trading day is over and all the chart reading and prep work for the coming week gets pushed off until Sunday, I thought I’d pass along some initial comments on the SPX and VIX correlation data I have been sifting through this morning.

The bottom line is that a highly correlated SPX and VIX does not bode well for the SPX across all the time frames I have been looking at, which start at three days and go out as far as three months.

The other important piece of information is that the recent relatively strong positive correlation between the SPX and the VIX that I discussed in “Divergence, History and Tells” is more historically significant that I first guessed. Without getting down in the weeds, suffice it to say that a six factor correlation model I developed gave 54 high correlation signals from 1990-1997 and only one cluster since then: 6 signals in the July 2003 and a lone signal in September 2003. That was until the current week, of course, which generated two very strong readings yesterday and the previous day -- and appears to be on course for another strong reading today, as both the SPX and the VIX are green as I write this.

You might think that the high correlation readings from 2003 would have presaged some of the bull market that was underway at the time. While you can make that argument looking out a period of more than a month, if you are looking out less than a month, even the 2003 signals were decidedly bearish.

I will have more on in this next week, but consider these comments as a heads up for those who are still pondering how to position their portfolio going into the weekend.

3 comments:

Trading Goddess said...

Happy Friday!

I saw this today and thought of you.

;)

Bill Luby said...

Hmmm. I was definitely born too early. I could have been a YouTube superstar -- at least for 15 minutes...

dk said...

I don't mind you getting down in the weeds for a little more detail on your 6 factor correlation model - lol. Very interesting stuff.

As we've touched on briefly, I suspect the VIX correlation patterns you're observing are related in some way to the elevated bearish readings the sentiment indicators are printing (I assume you've seen the May 3 AAII Bull Ratio -- wow!).

I continue to ponder Chenard's notion that the option market is uncomfortable that stock investors aren't more nervous.

Then there's the poorolditalian idea (also known as the Icarus theory) that it won't be over until the VIX and the market rise in epic parallel for a climatic, fiery finish.

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