Should Bulls Root for a High VIX or a Low VIX?

About two months ago, several readers asked me if I thought the markets could continue to make new highs while the VIX hovered significantly above its all-time low. My answer then, an enthusiastic “Absolutely!” has not wavered. In the interim, I have even managed to accumulate two additional months of data to support my case.

Today Bernie Schaeffer is talking up the same theme, this time with a piece bearing the lengthy title of “An Elevated VIX Points to Continued Gains: Why the Rising CBOE Market Volatility Index (VIX) Signals Less Complacency.” With titles like that, it hardly seems worth the trouble to read the few extra words in the body of the article that didn’t make it into the title, so I will save you the effort by highlighting his main points:

“The ratcheting up of the low end of the CBOE Market Volatility range from single digits to the floor in the 12-12.50 zone that has prevailed since March is, in my opinion, a major positive for the sustainability of this bull market.

The fact that premium sellers are demanding more for assuming risk is a direct refutation of the "complacency" argument those looking to call a top are so fond of trotting out. And to the extent there is less premium selling activity, the "speed bumps" that are created at strikes with large open interest that can often slow rallies to a crawl are mitigated.”

In short, Schaeffer and I are pretty much on the same page here in thinking that an elevated VIX floor is a contrarian bullish signal for the markets.

The one point of contrast I do want to emphasize is in the chart Schaeffer uses to support his contention that a high VIX is a bullish signal for the markets. In his SPX and VIX chart, Schaeffer displays the classic pattern of VIX spikes almost perfectly correlated with short to intermediate-term bottoms in the SPX. While I take no issue at all with the 10 to 20 day mean reverting characteristics of the VIX that I probably discuss here too often, the point I want to re-emphasize is that the long-term correlation patterns between the SPX and the VIX are a lot more problematic. If you look at a monthly VIX chart I posted awhile back, you can see extended periods of time where the SPX and VIX are negatively correlated (2003-2007) and others where they are positively correlated (1995-1999.)

The bottom line is that it is important to keep in mind that the shorter the time-frame, the more likely the SPX and VIX are to be negatively correlated. In the short-term, therefore, bulls should be adding to their positions when the VIX spikes; over the longer term, however, I would not be surprised to see both the SPX and the VIX to be moving higher in tandem.