Many investors treat the VIX, the Chicago Board Options Exchange Volatility Index, as a forward-looking market indicator. The VIX, colloquially known as Wall Street’s “fear gauge,” measures expected market volatility over the next 30 days. If you believe it’s an accurate forward-looking market indicator, a high VIX and high expected volatility would mean good returns ahead, while a low VIX and low expected volatility would signal poor future performance.
Ken Fisher, the founder of Fisher Investments, sees the VIX in a very different light. In his 2011 book, Debunkery, Ken Fisher debunks the VIX’s utility as a forecasting tool, concluding simply “when the VIX is high, the VIX is high. That’s about it.”[i] Before looking at how the VIX would have worked as a forecasting tool under various market conditions, it’s worth examining the VIX in greater detail and understanding how it might be used to predict market direction.
The VIX does a fairly good job of predicting future market volatility. It does this by using a range of S&P 500 Index options’ prices to forecast possible 30-day volatility for the S&P 500 Index. The VIX takes into account a wide variety of puts and calls—the two most common types of options contracts—to measure how much market volatility investors expect in the near future.
Investors who use the VIX as a forecasting tool tend to use it as a “fear index.” So a rising VIX means rising fear, and vice versa. And because stocks love to climb a “wall of worry,” logic would hold that surging fear means more bull market to come—making it time to buy stocks. Conversely, a low or declining VIX would indicate investors are ignoring risk, which foretells a market downdraft—making it time to sell stocks. Hence the saying, “When the VIX is high, it’s time to buy. When the VIX is low, it’s time to go.” The problem with this logic? Ken Fisher explains, “Volatility is volatility. It doesn’t tell you where stocks are going to go next”[ii] and it’s very difficult to successfully trade on the VIX’s relative troughs and peaks. To show this let’s evaluate the data for two periods: a short period in which the VIX worked as many believe it does—inversely correlated to the market’s future movement—and another period in which the VIX didn’t move like the market at all.
The VIX Is Useless Even When It Tracks the Market
In 1999, a pretty volatile year, the S&P 500’s peaks and troughs mirrored the VIX’s movements. Figure 1 shows movements of the S&P 500 (dark line) and the VIX (lighter line). The VIX was above 20 for much of the year—a relatively high reading. Technical analysts may point to this as proof the VIX is useful! For example, imagine an investor bought stocks when the VIX was at relative high points and sold when the VIX was low. She would have timed near-term market swings mostly accurately. However, as Ken Fisher reminds: “if you’d just bought and held the S&P 500 throughout 1999, you’d be fine—up 21.0 percent.”[iii] Perhaps more importantly, if you bought and held you wouldn’t have had to track the VIX meticulously—nor incur extra transaction costs and capital gains taxes.
Let’s take a closer look at the tactics of an investor trying to use the VIX in 1999. First, how would she determine exactly when to buy and sell? Does she buy at every VIX peak or only the big ones? This presents another hurdle for VIX proponents—how to know if it’s a peak (or trough) and which peak (or trough) to act on. Ken Fisher urges investors to “Look at the graph again—the highs and lows are all relative—you wouldn’t know a peak had formed until after the fact.”[iv] The VIX peaked higher at the start of the year, and then stocks moved choppily sideways. In mid-August there was another VIX peak (albeit lower than many points earlier in the year), yet stocks were retreating. And the VIX bottomed just before that market pullback, when adherents of VIX tracking would have expected a near-term market peak. Moreover, by the time an investor looks back and determines a VIX peak or trough, she likely missed the corresponding S&P 500 bottom or top in this example, because these inflections are coincident and there’s
“no lag in stock performance.”[v] So using the VIX effectively is difficult—if not impossible—even when it correlates relatively closely with the market.
What About When the VIX Doesn’t Track the Market?
Like most technical indicators, for every chart that shows the VIX works, there are plenty that show it fails. Figure 2 shows that 1995 was a great year for US stocks, with the S&P 500 up 37.6 percent![vi] Meanwhile, the VIX had no real discernable direction—just a lot of chop. What’s an investor to do with the VIX in a year like this? The VIX doesn’t even hint to an investor at the start of the year (or any time) when it’s time to get in.
VIXers may contend the VIX works during heightened volatility. However, 1995 was a volatile year—it was just almost all upside volatility! VIXers also like to claim the tool works when there is “heightened fear.” This is a perfectly fine rationalization, if one can reliably measure degrees of fear. Here again, only hindsight lets investors gauge relative fear. And even in hindsight, this perception is subjective. Humans’ survival instinct has been refined over eons of evolution to distort how we remember fear and pain—memory dulls the pain and warps the perception of fear.
Ken Fisher notes, “In some years, the VIX works great. In others, it’s just static.” He then questions: “How do you know when the “right” short time period for using the VIX has started? You don’t.”[vii] In our view, investors can’t reliably forecast markets using the VIX. While the VIX measures likely future volatility it doesn’t tell you anything about whether the volatility is likely to be positive or negative. And even if it did, it would likely be very hard to successfully use the VIX as a tool to time moving in and out of the market. So whether the VIX is high or low, Ken Fisher advises it’s time to look at other indicators.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
i “When the VIX is high, it’s time to buy.” In Fisher, Ken. Debunkery: Learn It, Do It, and Profit from It—Seeing Through Wall Street’s Money-Killing Myths. Wiley, 2011.
ii “When the VIX is high, it’s time to buy.” In Fisher, Ken. Debunkery: Learn It, Do It, and Profit from It—Seeing Through Wall Street’s Money-Killing Myths. Wiley, 2011.
iii Global Financial Data, Inc., S&P 500 total return from 12/31/1998 – 12/31/1999.
iv “When the VIX is high, it’s time to buy.” In Fisher, Ken. Debunkery: Learn It, Do It, and Profit from It—Seeing Through Wall Street’s Money-Killing Myths. Wiley, 2011.
v “When the VIX is high, it’s time to buy.” In Fisher, Ken. Debunkery: Learn It, Do It, and Profit from It—Seeing Through Wall Street’s Money-Killing Myths. Wiley, 2011.
vi Global Financial Data, Inc., S&P 500 total return from 12/31/1994 – 12/31/1995.
vii “When the VIX is high, it’s time to buy.” In Fisher, Ken. Debunkery: Learn It, Do It, and Profit from It—Seeing Through Wall Street’s Money-Killing Myths. Wiley, 2011.