Do Not Fear the Fear Gauge Yet

 | Mar 20, 2017 | 6:00 AM EDT
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One of the topics that seems to be discussed on a regular basis these days is volatility. Many ask: where has the volatility gone? Many wonder why the VIX -- which some call the Fear Gauge but is really a measure of volatility, not fear -- is so low and remains that way.

Let me report what I know about the VIX. I can promise you, it's not much! When it gets jumpy, I get interested. When it gets jumpy, we tend to see a market low. Outside of that, I have seen it get low and stay low. This is not new to long time readers.

I also know that one week ago we saw the put/call ratio for the VIX sink under 20%. As I explained on Tuesday last week, when this indicator sinks under 20% it means there have been far too many bets placed on the VIX going up (market going down). A contrarian would take that and say they can't all be correct and therefore the market should rally and the VIX should fall. So we end up with a day like last Wednesday.

That is short-term stuff. When the put/call ratio for the VIX gets so extreme, we get the shakeout, and as you can see we ended up with zero follow-through after Wednesday's rally. If I were to speculate on what it would take to get folks to pump up the VIX, then I would say the major indexes would need to crack. I've lost track of how many days we've gone without a 1% down move, but suffice it to say it's been one that is sure to go in the record books.

Take a look at the chart of Nasdaq, sitting right at the highs near 5900. Do you think a pullback to 5850 would scare folks? I say maybe. I do however think that a break of 5800 would get folks nervous enough to see the VIX move up. And yes, I know that's still 100 points lower than we see Nasdaq now.

The S&P has a somewhat similar issue, in that the uptrend line is relatively close, around 2365; but 2350 has been the support level for the last month or so. So here again, would a break of 2365 get folks nervous? I say yes. Under 2350, and I think the VIX would take notice.

There has been quite a bit of selling underneath, though. We already know the breadth of the market has lagged, although since Wednesday of last week it has improved. Yet the net volume figures have continued to erode. The TRIN, or Trading Index, was 2.0 on Friday, which is incredibly high. This indicator is the relationship between advancing issues and declining issues relative to advancing and declining volume, so a high reading generally indicates there has been quite a bit of selling underneath.

Here's the issue. The last time the TRIN was over 2.0 was Sept. 13. The S&P had declined 32 points on that day. Two days prior, it was down 52 points. The day sandwiched in between, we'd seen it rally 32 points. What's my point here? The market was very volatile, and there was a lot of panicked selling. Look at the VIX from then:

We see none of that volatility in today's market, yet the selling in individual stocks has been noticeable. In my experience, the erosion tends to persist longer than anyone wants it to, especially in today's world with so much passive investing. And that's why I think we won't see the VIX move until we see the major indexes break some important line that everyone cares about.

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