The Pick Up in Volatility is Great News

Over the past year the US dollar has been under increasing pressure and has been losing value against measures such as gold and major foreign currencies. During this time stocks have been essentially trading in a tight trading range and apart from a bit of strength during October and November of last year, volatility levels have been extremely low. We believe that the low volatility and the trading range environment masked a larger correction that had been taking place. Stocks were rising nominally in dollars, but when measured in Euros or in gold the indices have actually been in decline since December. Last week a sharp decline took on momentum unlike anything the market has seen in nearly five years. Expected oversold rallies never developed and selling progressed on heavy volume without relief. During this sharp sell off something interesting happened though, the VIX (a volatility measure) rallied sharply higher. Now, the VIX measure is fairly difficult to understand, but for the purposes of this report, understand that an increase in VIX indicates an increase in market volatility. So, in plain language, what has been happening over the past year is that the market has been in slight decline, but the decline has been masked by a weakening dollar. The combination of this led to very low volatility levels as measured by the VIX, which was also seen clearly by the narrow trading range. Now that the VIX has rallied sharply higher we can confidently say that volatility levels are picking up. In fact, the jump in the VIX has very real similarities to the 1994 market. This is very good news for us. A tight trading range is one of the most difficult market environments to navigate as buy/sell programs round out the extremes stopping rallies before they get started and stopping plunges before they plunge. In this type of environment it becomes ever more difficult to determine what is market noise and what is real demand. Recall what happened as volatility increased during the 1994 market. That year trading opportunities once again improved dramatically and preceded a huge bullish move that lasted over the next five years. We will discuss more of these implications over the next week. Right now, understand that we are now in a much better trading environment than we have been in for quite some time.