New research claims the bear market won’t end until the VIX says so. | Popgen Tech
By Mark Hulbert
Most bear markets end with stock investors in deep despair
According to one prominent investment firm’s VIX analysis, the stock market has yet to experience the capitulation that typically marks the end of a bear market.
By capitulation, I’m referring to the deep despair that leads investors to throw in the towel and swear off stocks. Although not every bear market ends in capitulation, most of them do. So Wall Street analysts are scouring the historical record for reliable indicators of capitulation.
The VIX — the CBOE Volatility Index — reflects options traders’ expectation of S&P 500 volatility over the next month, with higher levels indicating greater expected volatility. Since 1990, the earliest year for which the CBOE has historical data for the VIX, the highest ever close was 82.69 (as of March 2020). Lowest close ever in November 2017 at 9.14. It is currently in the low 20s.
A recent analysis by equity strategists at BNP Paribas concludes that the VIX is a reliable indicator of market capitulation and, therefore, useful in determining whether the bear market has come to an end. They found that the median VIX level at the bottom of the past bear market was 40.5, well above the VIX peak (at least so far) in the current bear market ( which is 36.45). In addition, since the firm found that spikes “in volatility came on average at the same time as troughs in the market,” they conclude that the bear market has not yet bottomed out.
The firm’s argument seems plausible, as the VIX stubbornly refused to move higher during this bear market — no matter how much market turmoil it suffered. Take what happened on December 15, when the stock market suffered its biggest decline in three months – with the Dow Jones Industrial Average dropping more than 750 points. The VIX that day closed with only 1.69 points, at 22.83. This closing level is in the 74th percentile of the historical VIX distribution since 1990, meaning that 26% of daily closes over the past 32 years have been higher. This certainly suggests that we are yet to experience capitulation.
However, investors should not bet too much on this message from the VIX. The median VIX level identified by BNP Paribas at the bottom of the past bear market — 40.5 — conveys false precision, as it is actually in the middle of a wide range.
Consider where the VIX has been at the bottom of the eight bear markets since 1990 in the Ned Davis Research calendar of bull and bear markets. It was generally from 28.14 to 61.59. In two of those eight, in fact, the VIX was lower than the levels it hit in both the spring and October of 2022. So it seems to be a stretch to confidently conclude, from the VIX itself, that the bear market was not. bottomed out at the market’s spring or October lows.
This wide range is also illustrated in the chart above, which reports the trailing 12-month return of the S&P 500 as a function of the VIX. Although the average return is correlated with the VIX level, note from the green columns the range between the best and worst returns of the stock market. Any bet based on the data of this chart must be a low confidence bet.
Consider what happened during the Global Financial Crisis. Before the GFC, the VIX never rose above the high 40s. So when the VIX rose to that level in October 2008, many of the market timers my firm monitors confidently bet that the bear market was at or near its end. They were wrong. Stocks continued to slide. The VIX in November 2008 would rise to close to 90, and the bear market would not end until the following March, when the S&P 500 was almost a third lower.
Also consider the notion that a spike in the VIX indicates that the bottom of the bear market is near. For every bear market since 1990 in the Ned Davis Research calendar, I calculated the number of days from the date the VIX peaked to the date the bear market ended. The average was 57 calendar days, or almost two months. While in the case of one bear market the peak of the VIX occurred on the exact day of the bear market low, in another case 171 calendar days (almost six months) occurred between the peak and the end. Again, that’s a pretty wide range.
So even if the VIX in recent days had risen enough to suggest a capitulation, we still couldn’t conclude that the bear market was at or near its end.
These observations are not intended as a criticism of PNB Paribas research. Since there is no agreed definition of what capitulation is, imprecision is inherent in any attempt to measure it. This is why some analyzes have suggested that the capitulation has already taken place, while others — such as PNB Paribas research — suggest not.
The bottom line: The picture is mixed, but this is hardly surprising. It will never be the case that all indicators point in the same direction. On the one hand, it is true that, if the VIX had risen much higher in recent sessions, the weight of evidence would be more inclined to believe that the bear market is nearing its end. But, on the other hand, such an inclination would be extremely small.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be verified. He can be reached at email@example.com
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