You’ve probably heard/read a lot lately about the VIX index. The VIX index is a measure of the implied volatility of S&P 500 index options. The VIX is popularly known as a market “fear” index. The concept underlying the VIX is that it measures the theoretical expected annualized change in the S&P 500 over the next year. It’s measured in percentage terms. A VIX reading of 10 would imply an expectation that the S&P 500 could move up or down 10% or less over the next year with a 68% degree of probability. The calculation for the VIX is complicated but it basically “extracts” the implied volatility from all out of the money current-month and next month put and call options on the SPX.
The graph above plots the S&P 500 (candles) vs. the VIX (blue line) on a monthly basis going back to 2001. As you can see, the last time the VIX trended sideways around the 11 level was from 2005 to early 2007. On Monday (May 8) the VIX traded below 10. The last time it closed below 10 was February 2007. The VIX often functions as a contrarian indicator. As for the predictive value of a low VIX reading, there is a high correlation between an extremely low VIX level and large market declines. However, the VIX does not give us any information about the timing of a big sell-off other than indicate that one will likely (not definitely) occur.
In my opinion, an extremely low VIX level, like the current one, is signaling an eventual sell-off that I believe will be quite extreme.
The true fundamentals underlying the U.S. economy – as opposed the “fake news” propaganda that emanates from uncovered manholes at the Fed, Wall Street and Capitol Hill – are beginning to slide rapidly. The primary reason for this is that the illusion of wealth creation was facilitated by the inflation of a massive systemic debt and derivatives bubble. Government and corporate debt is at all-time highs. The rate of debt issuance by these two entities accelerated in 2010. Household debt not including mortgages is at an all-time high. Total household debt including mortgages was near an all-time high as of the latest quarter (Q4 2016) for which the all-inclusive data is available. I would be shocked if total household was not at an all-time high as I write this.
The fall-out from this record level of U.S. systemic debt is beginning to hit and it will accelerate in 2017. In 2016 corporate bankruptcies were up 25% from from 2015. So far in 2017, 10 big retailers have filed for bankruptcy, with a couple of them completely shutting down and liquidating. Currently there’s at least 9 more large retailers expected to file this year. In addition to big corporate bankruptcies, the State of Connecticut is said to be preparing a bankruptcy filing.
The household debt statistics show a consumer that is buried in debt and will likely begin to default on this debt – credit card, auto, personal, student loan and mortgage – at an accelerated rate this year. The delinquency and charge-off statistics from credit card and auto finance companies are already confirming this supposition.
In the latest issue of the Short Seller’s Journal, I review the VIX and the deteriorating consumer debt statistics in detail and explain why the brewing financial crisis will be much worse than the one that hit in 2008.