Avoid Market Swings by Following the Fear

There are many measures of market volatility, but the VIX gets quoted more often than any of the others. That's probably because it has come to be widely known as "the fear index." Investors often use the options tapped to calculate the VIX to insure themselves against losses from market swings. An option enables an investor to buy or sell a stock at a preset price. The more fearful investors become about losing money on their investments, the higher the cost of the options, and the higher goes the VIX. Market technicians often cite a high VIX as a strong signal to buy equities.

The MOVE Index is calculated daily, showing the range in which Treasury bond yields are anticipated to move over the next 12 months. Like the VIX, it is expressed as a single number. If the MOVE is at 100, that means investors expect the high-low range for yields during the coming year to be 100 basis points. Each basis point equals .01 of a percentage point. Thus the MOVE at 100 suggests that yields on a 10-year Treasury with a current yield of 5 percent would range from 4.5 percent to 5.5 percent over the following year.

This index had been moving mostly in the 55 to 75 range from the start of last year until late spring of 2007. It hit a low of 51.20 on May 15. In June, it rose to about 85. On September 12, it reached 124.50.

"We haven't seen this before," Simenstad says. He and Francis tick off other uncertainties that have been rattling both the equity and credit markets.

Uncertainty Unleashed

In September, the Bloomberg News Service reported that a flight to the safety of government debt had caused the widest price swings in Treasuries in three years, and yields on three-month Treasury bills swung by 10 or more basis points on 15 days in August. The market saw similar swings on only six days from 2002 until the start of July in 2007, and on only five days following the September 11 attacks, according to Bloomberg.

Uncertainty about the scope of losses in the subprime mortgage industry triggered much of the trauma in the credit markets this summer. "We haven't seen this before," Simenstad says. He and Francis tick off other uncertainties that have been rattling both the equity and credit markets.

They say the biggest uncertainty is the repricing of risk, a process that kicked into gear this summer. Another factor is housing. The downward spiral in U.S. housing could hurt the overall economy in many ways. One is that households facing ballooning payments on adjustable-rate mortgages could curb their consumer spending. "Housing is much more shaky today than it was a couple of years ago," Francis says. Higher oil prices and an unpredictable global political situation also contribute to uncertainty, they say.

Another imponderable: the continuing rise of short-term and speculative trading by hedge funds, often across international borders. "There's so much more fast money in the markets now," Simenstad says. All of these uncertainties suggest we'll be seeing more, not less, market volatility in the years to come.