Heed Vix and Ted
It’s still too early for serious monetary decisions
BOTH THE Vix index – at 55% – and the Ted spread – at 4,30% – are warning investors, the owners of money, that it’s still far too risky to invest in anything other than US Treasury bonds with a threemonth period to maturity. Yes, investors – and anyone else who’s interested – will have to get used to the two market concepts of Vix and Ted, which, thanks to the ongoing crisis on the world’s financial markets, are now generally used by commentators.
The Vix index, informally also known as the fear index, measures the volatility of financial markets. When the Vix index explodes, like the current 55% (just a few days ago, it was still on 71%), it tells participants in the financial markets they don’t have the vaguest idea what’s happening. Investors don’t know whether prices are going to rise or fall, nor by how much, and the total uncertainty is measured by this volatility index, the Vix.
Investors don’t have to bother too much about how the Vix is calculated. The Chicago Board and Exchange does that on the basis of the prices at which call and put options trade relative to underlying share prices.
The interpretation of what the Vix index means to investors is far more important. The box shows the current Vix index as 55%. That’s per year. To convert that to a monthly figure it’s divided by the square root of 12: that is, about 3,46 for easy future reference. The 55% Vix index divided by 3,46 gives an answer of around 16%. That means US market players expect share prices will fall, rise, by 16% over the next month.
Vix gives no indication of the direction. A few days ago, when Vix was still more than 70%, it predicted share prices would rise fall by 20% over the next month.
How dangerous is a Vix of 55% that predicts that prices are going to rise or fall by 16%? Over the past few days, both nearly happened. Just two days around 10 October were necessary for a 16% decline in the Dow Jones index, while for two days around 13 October there was an interday rise of almost 16%. That sort of fluctuation is far too big. It doesn’t matter how clever or lucky you are: mistakes are going to be made.
The more sensible investor stays away and says no thank you when the Vix is as high as it is now. Wait for the volatility to fall to less than 20%, which will mean share prices won’t rise or fall by more than about 6% over the next 30 days. Check whether there’s a clear rising or falling trend and then invest. Keep away when a Vix of 50% or more tells you so.
It doesn’t matter how clever or lucky you are: mistakes are going
to be made.
Another indicator of what was suddenly big news over the past few weeks is the socalled Ted spread. That until recently strange phenomenon measures the difference between the interest rates on US three-month Treasury bonds (by definition, the world’s safest monetary investment) and the three-month London Interbank Offered Rate (Libor). Traditionally, it’s only about one percentage point or 100 basis points on the Treasury exchange rate.
The Ted spread graph shows the rate on the three-month Government bonds was around 3%/year at end-January and banks were prepared to lend one another money at 4%/year without security. The difference was one percentage point. For larger banks, it was slightly less; while small ones, such as SA’s Investec, that are active in this market would have paid slightly more.
But from September, the banks no longer trusted one another. The rate on Treasury bonds fell sharply to just 0,5%/year when the Libor rose to 4,5%. Currently, the Ted spread – a measure of risk associated with banks – is 430 points if you look at the latest price available on bloomberg.com.
Wait for the Ted spread, which measures risk in the financial sector, to fall to no more than 200 points, preferably 100, and wait for the Vix index, which measures fear and volatility, to fall to 20% before you can confidently make new deposits in any financial assets other than a money market deposit at one of SA’s leading banks.
And when you’re standing around the braai this weekend don’t risk any predictions about when the world’s financial system will recover or collapse without some knowledge of the latest Vix index or Ted spread – though you may feel free to say who’s going to win the Currie Cup final.