VIX Signal Redux?

Thursday, December 18, 2003 | 12:03 AM

Back in mid-October, we noted that a significant slide in the VIX to the 16s was signaling an imminent short-term correction. That call saw the Dow drop nearly 5% over the next 10 days, and the Nasdaq give up well over 100 points. So you may imagine our excitement on Tuesday and Wednesday as we watched the VIX break 16, and continue south to 15.52, making a fresh 52 week-low.

Unfortunately, we cannot make the same call on either the VIX or QQV, the volatility index for the NDX (See charts nearby). The VIX move in October, from 23.26 to about 16.19 represented a drop of over 30%. The recent VIX drop began from just over 18, and poked beneath 15.52 for a 15% move - half of the prior signal. This is not enough to get us excited that massive complacency has set into the market. While there is some lack of fear, it is not yet at levels that reliably signal an imminent reversal or sell off.

Seasonality fights complacency?
Additionally, there are two unrelated factors working against a late December VIX call: Seasonality, and deferrable taxes. Seasonality includes the “Santa Claus Rally” and so called “January Effect.” According to the ’Stock Traders Almanac, the Santa Claus rally includes the last 6 days of the year, and the first 2 days in January. The January Effect typically starts mid-December, and runs through the first week of January. A variety of reasons underlie why this period is typically positive; space does not permit a full exposition here. Suffice it to say that the markets have historically enjoyed positive returns near the end of the year.

Not only Cub’s fans say “Wait ‘til Next Year”
As we head into year’s end, another element working in favor of equities is the reappearance of our old friend, Capital Gains Taxes. This being the first winning year in three, investors’ thoughts are turning to our ever-present dependent, dear old Uncle Sam. I’ve been hearing from a variety of institutions and individuals that are delaying ‘hitting the bid’ until January 2004. A profitable sale made in December 2003 has a tax bill due in a mere 4 months; Waiting until January to make that sale gives the seller a full 16 months, until April 2005.

This is reminiscent of ’99, as I recall seeing so many charts gone vertical late in the year, all of which were technically begging to be sold that December. Time and again, all manners of investors insisted on waiting until 2000 to make the sale - for the same tax deferral reasons. Given how 2000 turned out, this crafty strategy worked well. By the end of the year, most people had losses sufficient to offset their taxable gains that calendar year. Compare this with offsetting a mere $3,000 per year in losses, forever.

Taxes delayed are not taxes denied, but . . .

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