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Sometimes when you're investing in the stock market, it's easy to get focused only on the stocks that you are watching in your portfolio. However, it's important to remember the larger macroeconomic, political and fundamental forces that are driving the market at large. After all, it is often these forces that account for the majority of any individual stock’s price movements during a given day, week or year. At Learning Markets, we always try to start with a 30,000 foot view when we make any investing decision, and that's what we're going to do in this Market Commentary blog: keep the big picture in perspective.

Is the market really too bullish?

To some it appears that the market is racing to new highs faster than Mr. Quiggly, the French bulldog made famous by his 30-second commercial for Skechers’ running shoes during the Super Bowl. Perhaps in similar fashion to Mr. Quiggly’s quick turn at the finish line, they expect to see the market suddenly reverse direction any time now.

Some would say there is good rationale for expecting a pull back. Negotiations over Greek’s effective bankruptcy are still on the brink. Some question whether an agreement that allows Greece to only pay back some of what they borrowed—as opposed to simply paying back nothing--may not be reached in time for the necessary bond payoffs in March. But would a Greek default be alarming news to the market now? Six months ago it was alarming news, but right now not so much. By some measures it appears that markets are now ready to weather the storm regardless of the outcome.

Consider this weekly chart of the CBOE Market Volatility Index (a.k.a. the VIX). In simple terms the VIX is a measure of how many investors are buying options. More specifically it measures whether they are buying put options—those options that protect from falling prices. Many analysts look at the chart of this index and point out that the market is ready to increase in volatility.  

Now the phrase “increase in volatility” is market-analyst jargon. The translation is roughly “prices will soon fall off a cliff.” Since the VIX is at the level where it dramatically rose last time, many may expect that it will do so again. Both of these rapid rises in the VIX coincide with dramatic market downturns: in 2010 it was the flash crash; in 2011 it was the debt debacle. Will 2012 feature a noisy selling spree just like the last two years? Actually, it may not.

If investors are truly fearful of the consequences surrounding a default by Greece’s government, they aren’t showing it. If they were, the VIX should be much higher right now.

Instead it is worth noting that this level of the VIX (around 17.5), was the same level reached midway through 2003. That was, of course, at the beginning of a 4-year bull market run. Once the VIX reached that level and dropped lower, it stayed that way for quite a while as the market moved higher in a slow-and-steady manner.

Since the VIX is an indirect measure of how many investors are buying put options, or in other words those that fear falling prices, the current level of the VIX is a possible indication that the market is not in fear of Greek default. Perhaps investors recognize that such a default would merely sour the world’s bond investors and drive many investors into stocks. Indeed U.S. debt problems have certainly not disappeared. Might we be approaching a period of time where stocks look like the safe investment next to bonds?  If we can imagine a French bulldog besting greyhounds, why couldn’t we imagine a rising market in the face of negative uncertainties?

by Gordon Scott, CMT - Learning Markets Analyst
Posted by learningmarkets on Feb 9, 2012 3:06 PM CST