Does the big spike in the VIX fear index signal the bottom of the bear market?

Traditionally, the CBOE Implied Market Volatility Index or VIX, also known as "the market fear index", spikes up sharply when market sentiment is most negative and usually indicates a market bottom and the transition from a bear market to a bull market. Unfortunately, VIX (or actually the market) frequently has a mind of its own and there is no precise science to VIX analagous to calculating missile or artillery trajectories in the face of gravity. There are frequently a whole series of sharp spikes over a few days and only the last is the final signal of a turn in the market.

The composition of VIX was adjusted in September 2003, so we actually have not seen a true panic and capitulation with the new VIX. In theory, the older data has been adjusted to mesh cleanly with the new VIX methodology, but I am unpersuaded and will remain so until we have a full-blown panic (ala 1987 and 1998) behind us.

The old VIX hit 140 on October 20, 1987. Old VIX hit 48.56 on October 8, 1998, but spiked above 45 four times before hitting that final high that marked capitulation.

New VIX hit 64.92 today and has closed above 45 on six occasions recently before today. It closed above 50 three times before today. That is clearly a greater degree of panic than in 1998.

In the Summer and Fall of 2002, new VIX closed above 45 only one day, barely, and another earlier day almost to 45, and above 40 on ten occasions before beginning a new bull market. The final spike was only up to 42.13. Actually, this was with old VIX, but the old data has been adjusted to mesh with new VIX.

In short, from a historical perspective the current VIX spikes are definitely panic-level and worse than 1998, but not as bad as in 1987. Ultimately, it is not the spikes themselves that mark the market turn, but some external catalyst that reverses sentiment. Despite the level of the latest spike, quite literally anything could happen.

Personally, I think there may be a fair degree of ongoing panic dumping of mutual funds by nervous retail investors and they are unlikely to know anything about VIX and simply keep dumping until they are no longer in the market. And hedge funds and short-sellers will piggyback on that selling pressure until it finally peters out.

There is another way to achieve true, market-turning capitulation and that is simple, old-fashioned "selling exhaustion", where everything who is going to sell has done so and the selling simply stops, dead cold, and traders notice that and begin buying again without fear that somebody is sitting there ready to start selling again. The problem is that there are always short periods where selling stops for various logistical reasons and then starts up again as the logistical obstacles are removed. And, sometimes people really do intend to hang in there, but simply run out of time and sell even though the market has made a clear turn. Or maybe a mutual fund starts selling again because retail investors get nervious based on some news report and dump shares.

-- Jack Krupansky