Fear Returns

March 7th, 2012

Nick Hays

Dhaka, Bangladesh

Today - on The Long and the Short:

* Fear returns

* VIX break-out?

Major stock indices took a nose dive yesterday while the VIX “fear index” spiked over 15% during the biggest one day equities sell off of 2012 to date.

After two weeks of relatively calm and flat trading, some of the risks I identified in my earlier post here appear to have bubbled to the surface. Amongst them are renewed doubts regarding the finalization of the Greek debt deal, the increased probability of slower Chinese economic growth in future, and signs that the Fed will press "pause" on any further monetary easing for the time being.

Whether this is the start of a larger correction or not remains to be seen. What is clear to me is that risk had been significantly under priced and yesterday was a much needed splash of cold water on the markets.

What is more, one chart that I'm watching closely is indicating that things could be about to get worse:

As you can see in the above chart, since late December the VIX has been trading in a downwards sloping channel, indicated by the red lines. Technical analysts use charts to work out possible areas of ‘resistance’ and ‘support’ for prices. The trading channel I’ve identified is not perfect but yesterday’s price action on the VIX may suggest that it has broken out of this channel and is poised to go higher. Given the negative correlation between the VIX and risky assets such as stocks, a spike in the VIX would point to lower prices for the major indices.

Much will depend on the outcome of this week’s Greek PSI (Private Sector Involvement) negotiation. The Iran situation also remains very much a wildcard event with the ability to send major shockwaves through the markets. Recent Obama rhetoric in my view has increased the probability of an escalation in the Middle East. (Interestingly from a local perspective here in Dhaka, a Saudi diplomat was shot dead at close range yesterday in my neighbourhood - perhaps inevitably, media speculation of an "Iran connection" is rife.)

Very interesting times indeed, let’s keep watching…