The most important development in the U.S. financial markets during the past week was VIX climbing to 18.14. This is the highest reading during the last 90 days. Today, Monday, February 3, 2014, VIX surged to an intraday high of 21.13. In all of 2013, VIX never reached 22, which included periods when the S&P 500 was significantly lower than it is now.
What VIX is telling me is that investor fear is surging far faster than the percentage decline in equity indices would justify. Therefore we reckon the current pullback will be short-lived. We are likely to experience a significant bounce for nearly all equity sectors sooner than later.
In other words, the more quickly that fear materializes in the form of investors protecting themselves against a further loss, the more likely that the stock market will soon rebound. This recent panic and elevated VIX implies that some investors are panicking first and asking questions later, which rarely leads to an extended bear market. We anticipate that near future corrections will be followed by sharp short-term upward bounces for perhaps another year. We will probably experience one or two double-digit pullbacks along the way for SPY and IWM. The most severe market correction will probably occur in 2015 and 2016.
On the flip side, in our experience, whenever VIX is slow in responding to a stock-market retreat, which will probably happen during the latter part of 2014, the irrational complacency will lead to a continued equity decline.
