Forecasting the S&P500 using the VIX
by Chart School - September 20th, 2010 3:45 pm
Forecasting the S&P500 using the VIX
Courtesy of Rohan at Data Diary
McClellan Financial Publications had an interesting analysis last week (here) that looked at “Tracking the VIX response to Price Moves” in the S&P500. A key conclusion of the analysis was that divergences between the two indexes can signal turning points in the S&P500.
The concept seemed a good one – worthy of further investigation.
However, rather than asking how the VIX responds to changes in the S&P500, we turned it around and asked how does the VIX anticipate changes in the S&P500. Perhaps it’s the same question – as who knows which leads which. In any event, it seemed easier to understand a model that mapped the S&P500 as implied by movements in the VIX.
So following are the charts of the actual S&P500 and that implied by movements in the VIX starting from 1Oct09:
Our results are broadly similar. Three key divergences between the VIX derived S&P500 and the actual price were identified that did indeed precede changes in price direction. At price extremes, there arose a disconnect between the behaviour of option traders and the broader equity market.
Most unhelpfully, the seeming catalyst for McClennan’s article – that we may currently be witnessing another divergence developing was not really confirmed. Though it’d be fair to conclude that the derived S&P500 chart has all the hallmarks of a market undergoing a topping process. We’ll watch this indicator with interest to see how things develop from here.
Epilogue:
Note that correlation changes over time and, not unsurprisingly, falls the longer the period under consideration. So that the correlation is ~74% for the period 2004 to today, rising to 79% from Jan08, and is 85% for the last year. As with most time series analysis, the start date will have an impact on results.
In backtesting though the analysis retained its value. For example, there was a significant divergence between the VIX derived S&P500 and the actual S&P500 index around the March 2009 lows. The longer term data set is as follows- note the relative performance through 2007:
CHART OF THE DAY: REVISITING THE MARCH LOWS?
by ilene - June 23rd, 2009 10:14 pm
If history repeats, keep this chart in mind.
CHART OF THE DAY: REVISITING THE MARCH LOWS?
Courtesy of The Pragmatic Capitalist
According to Bloomberg and Jim Reid, we’re likely to see much lower valuations (and stock prices) at some point in the next few years:
June 22 (Bloomberg) — U.S. and European stocks are destined to fall below March’s lows if bear-market history is any guide, according to Jim Reid, a strategist at Deutsche Bank AG.
Share prices tend to hit bottom “at extremely cheap levels” relative to earnings during so-called secular bear markets, Reid wrote five days ago in his first equity strategy report. Secular bears consist of multiple rallies and declines, with each slump producing lower valuations than the prior one.
The CHART OF THE DAY shows the Standard & Poor’s 500 Index’s price-earnings ratio since 1900, based on data compiled by Yale University’s Robert Shiller and cited in Reid’s report.
Shiller calculated the P/E ratio at 6.6 in September 1982, just before the 1980s bull market started. The gauge sank to less than six in the depths of the Great Depression and at the beginning of the 1920s. This year, it has stayed above 13.
“History tells us that at some point in the next decade there will be much more stressed valuations than today and a once-in-a-generation buying opportunity,” wrote Reid, who previously focused on credit-market strategy.
Even “a large rally” later this year and into 2010 may not be enough to prevent this scenario from unfolding, he added. The S&P 500 has climbed as much as 40 percent from its March 9 lows. Reid’s European benchmark, a local-currency version of the MSCI Europe Index, has risen as much as 33 percent.