Being a contrarian on Wall Street and betting against conventional wisdom is so popular it makes you wonder whether the true contrarians are the ones who never stopped believing the conventional wisdom in the first place.
Perhaps nowhere is this more true than the VIX, the Chicago Board Options Exchange Volatility Index which is known as the “fear gauge” by some and probably the “let’s party gauge” by contrarians.
Since the gauge of Standard & Poor’s 500 Index options prices is generally viewed as a measure of concern that stocks will fall, at first blush conventional wisdom would suggest an elevated VIX means investors are girding against more losses.
Of course a contrarian will retort that “when the VIX is high, it’s time to buy.” It’s hard to argue against someone with such a catchy rhyme so that bit of contrarian thought has grown to the point of becoming the actual conventional wisdom.
CXO Advisory Group has examined the relationship between the VIX and the S&P 500’s performance and the results are worth noting even though they don’t rhyme:
“The level of VIX explains less than 1 percent of the variation in S&P 500 Index returns across all horizons,” CXO wrote in yesterday’s report. “Results generally do not support belief that the level of VIX predicts stock market returns.”
CXO is not the first to make the case. Birinyi Associates Inc. said this back in 2010: “The VIX is alleged to be an indicative indicator and has become a staple of analysts and journalists alike. We respectfully disagree and ultimately conclude it is a measure of current volatility with little or no predictive or indicative value regarding the course of the market.”
CXO looked at the performance of the S&P 500 five, 10, 21, 63 and 126 days following highs and lows in the VIX, starting with when the fear gauge was created in 1990.
The entire history of the index does show some positive correlation to future returns that are “slightly favorable to conventional wisdom” that when the VIX is high it’s time to buy.
“Correlations vary considerably across subperiods, relatively strong during the 1990s and 2010s (partial) but much weaker during the 2000s,” CXO wrote. “Inconsistency across subperiods undermine belief in reliable relationships.”
Now the CXO report lays out all the math to back this up including Pearson correlations and R-squared coefficients, but let’s be candid: math is hard and it’s Friday and all anyone really cares about today is who the heck shelled out $38.1 million for that red 1962 Ferrari at last night’s auction.
A true contrarian would’ve bought a ’76 Pinto.