May has been a cruel month for investors and market watchers. It's been the month of fear. The Wall Street Journal reports that the Chicago Board Options Exchange's volatility index, or VIX, otherwise known as the fear index, hit its highest point since April 2009.
The fear index is pretty simple. When it rises, it means investors are scared the market is becoming more volatile and will swing unpredictably.
There is a whole range of reasons for this. We have the news out of Europe and fears about the possibility that Europe's debt crisis might spread around the world and kill off what chance there is of recovery in the United States with former Federal Reserve chairman Paul Volcker telling us that Europe is a warning call to the US, we have mortgage delinquency rates in the United States rising to record levels, warnings that China's bubble is about to burst and wild swings in oil prices in an otherwise flat economy.
The problem is that the volatility is getting worse which means the fear index is likely to hit a record high. As I said in my blog last week, Morgan Stanley's Asia chairman Stephen Roach says the crises are now coming faster than ever. There used to be a gap of three years between crises, now it's 18 months. When you think about the last three years, we have seen the subprime mortgage crisis morph into the market meltdown and global financial crisis morph into the European debt crisis. What's next?
In Barrons, Bill Luby tells us that volatility can make professional traders look stupid. The issue, he says, is that investors underestimate big upward moves in volatility as they unfold and overestimate future volatility after a big volatility spike.
And that's the problem. What's the volatility telling us? Is it predicting a crash or have investors become too scared and pushed the needle too far into the red zone? We won't know until the market moves into the rear view mirror.
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