Heed Vix and Ted

It’s still too early for se­ri­ous mon­e­tary de­ci­sions

Finweek English Edition - - Openers - VIC DE KLERK vicd@fin­week.co.za

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.

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