With the VIX Below 16, Fear Looks Cheap

We recovered from our spell of passion yesterday, only to discover the index of America’s largest companies really has crossed 11,000, closing the day at an 18-month high.

Barely a year ago, investors were clutching their Bibles, soaked in sweat, watching the Dow plunge below 6,600. Today? Who’s’ worried about a correction?

“We’ve definitely turned the corner,” some Wall Street analyst told the Journal.

Definitely? That’s our cue to place bets against the rally.

We’re definitely among the minority, however. The volatility index fell to its lowest level since June 2007 this week. The VIX is at 15 today…light-years from the 80-90s suffered during Lehman’s collapse.

Low Volatility Index

Even in the 20-year history of the index, 15 is low.

“Fear gives intelligence to fools,” says Chris Mayer, citing the old proverb. “Turning it around a bit, we might say that lack of fear makes fools of wise men.

“Right now, fear looks cheap. With the VIX below 16, we are getting close to extreme territory. We are near the limits of what that great rubber band of life will absorb before it snaps back. The VIX usually hovers between 10-20. So we are not quite there yet, but the tension is building.

“Given all that is going on in the world, it is remarkable to find investors so unworried. The financial system is still a rather creaky affair. Leverage is still high. Banks remain undercapitalized. The credit cycle has not yet run its full course, as there are still significant credit losses hiding in the cupboards of banks.

“Then there are the governments of the world. The US has awful credit metrics. It is bleeding money and owes huge debts. The states are also bleeding money and have large debts, including giant gaps in unfunded pension liabilities. They are perhaps worse off, because unlike the US government, the states cannot print their own money. Then there is the EU. And Japan.

“There are only a few ways to cure such ills, and none are painless. One thing is for sure: These ills can’t go on forever. So despite being in the middle of a usual historical range, these are not usual times. In the context of our times, fear looks cheap.”

Addison Wiggin
for The Daily Reckoning