Wall Streets so-called fear gauge, the CBOE Volatility Index (CBOE: VIX ), has
experienced a stunning decline so far this month, but investors need to be
extremely careful about what they read into this. December VIX performance is
notoriously unreliable and prone to reversal, and at this point it may actually
be a contrary indicator for the broader market. The VIX declined into the low
20s on Wednesday morning, compared with its level of 30.91 on Dec. 8 just nine
sessions ago and a recent peak above 35 on Nov. 21. Notably, this move hasn't
been accompanied by a major upturn in the market. The S&P 500 is virtually
unchanged from its Dec. 8 low through early on Dec. 21, and its up only 4.5%
since Nov. 21. With so little movement in the market, why the big move in the
VIX? The answer is seasonality. The VIX has a strong downward bias in December,
due to the high number of holidays and slow trading days in the 30-day forward
window it captures. According to the blog vixandmore.blogspot.com , the VIX has
hit its calendar-year low in the week before Christmas in five of the past eight
years. During this time, the VIX has its low on Dec. 24 once, Dec. 23 twice and
Dec. 18 once. It's a remarkable, high-probability trend that doesn't get
nearly as much attention as it should. Three other key points to consider amid
the flood of reporting we're likely to see about the collapsing VIX in the
days ahead: Europe's Still on the Ropes: The main reason for the elevated VIX
that has been in place during 2011s second half is, obviously, the concerns
about a worst-case scenario unfolding in Europe. And during the past week, no
fundamental changes in the Continent would warrant such a decline in the VIX. If
anything, the situation has gotten worse with the talk of potential downgrades
to France and the U.K. This is confirmed by the iShares MSCI Europe Financials
Sector Index ETF (NASDAQ: EUFN ), which has nearly round-tripped from its
October rally and is within striking distance of new lows. Typically, this kind
of disconnect between VIX performance and the underlying fundamental trends
concludes with an upward reversal in the VIX. December VIX Drops Usually Prove
Short-Lived: During the past 10 years, the VIX has closed on Jan. 31 above its
low of the previous six weeks in every year. The exact timing of the low point
can vary: While it frequently occurs around Christmas, in several years the
index didn't put in its low until the first or second week of January. The
takeaway is that while picking the low can be difficult and when isn't it?
the trend for the VIX in January is clearly upward. Falling VIX Caps Market's
Upside:
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