Friday, October 23, 2009

Nix the VIX?

The volatility index has been frequently touted as a strong signal for equity market entry and exit. A high VIX measure sends investors to the sidelines to await a less volatile trading atmosphere and a low VIX brings investors back to the market in droves. The volatility index reached a high of 89.53 in November 2008 and finally returned to levels below 30.00 in January 2009. The VIX has not been below 15.00 since mid-2007.

The continued high volatility suggests considerable divergence in view on the economy and stocks in general. Economic signals remain mixed at best with high unemployment and erratic demand in all sectors. The fact that credit markets appear to have stabilized has apparently not been taken as a bullish signal. Thus, far from dysfunctional, the VIX is providing a valid measure of market sentiment that could otherwise be characterized as not just lacking conviction but confidence.

The VIX has descended from those extraordinary highs a year ago, but no investor should consider the current equity markets in the U.S. as back to normal. This suggests that buy ratings or accumulate rates such as those used by sell side and independent analysts such as Crystal Equity Research should be considered against the backdrop of higher volatility. Today’s “buy rating” is not the same buy rating of two years ago. We have attempted to compensate for the increased risk through adjustments in valuation metrics, assigning lower metrics even to companies that we continue to want to own and are therefore rated buy.

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