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Money Matters

October 17, 2022 by Scott Crosby - Views: 33

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Investors Column

S428-1.jpgIf you follow stock prices, one “stock” symbol you may not have seen is “VIX”.  It is actually an “index” symbol, like that for the Dow Jones Industrial Average (DJIA or Dow), the S&P 500, or NASDAQ.  Those three indexes tell you something about a particular segment of the stock market as a whole.

The DJIA index is computed via a rather complex equation that is based on the stock prices of thirty companies which are intended to represent the various segments of the economy, so that the DJIA represents status of the economy as a whole.  

The companies included in the Dow are for the most part traded on the New York Stock Exchange (NYSE), but that changed when Apple Computer (AAPL) was added to the Dow.  Apple is traded on NASDAQ, and has never applied to join the NYSE.  Nevertheless, since Apple has the highest “market capitalization” (the company’s stock price multiplied by the number of shares of its stock held by all of the many owners of that stock) of any company, the managers of the DJIA realized that it made sense to include Apple in calculating the index.

Similarly, the S&P 500 index is a composite score based on the 500 companies with the highest market capitalization.  The premise is that the S&P 500 represents the value of the vast majority of the country’s total economic value, and more:  since each of those companies purchases products from other companies, the S&P 500 is actually a more comprehensive indicator of the state of the economy than just those 500 companies on the list.

The NASDAQ index is a composite indicator of the largest companies which are traded on the “over-the-counter” market; i.e., companies which are not listed on the NYSE.  Thus it seeks to indicate how smaller, less well-known companies are performing.  However, the NASDAQ also includes companies like Apple and Microsoft.

The VIX

The VIX is a rather unusual index.  First, the better that people think the economy is doing, the lower the VIC goes.  The worse that people think the economy is doing, the higher the VIX goes.

The VIX index is based on something called “options” trading.  The VIX goes up when more options trading occurs, and down when less options trading is being done.  Options involve “puts” and “calls”.  Trading in options is extremely difficult, and can easily result in severe losses.  Options trading is not recommended for the readers of this column.

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However, the reason for tracking how the VIX is moving is that the VIX indicates how people believe the economy will be faring in the months ahead.  When the VIX goes up, it means people think the economy is going to decline.  When the VIX goes down, it means people expect the economy to generally improve.

For example, note the graph of the VIX for the past ten years.  Up until 2020, the VIX stayed relatively low, with a few small spikes corresponding to the normal fluctuation of the economy.  The big spike in 2020 is, of course, due to the COVID outbreak.  People made the obvious conclusion that the pandemic would be bad for the economy.

What is key to note now is the fluctuations and repeated spiking ince late 2021.  VIX values in the 30s are unusual, and indicate that people are very apprehensive about the state of the economy.  And there can be no doubt that we are in a fairly nasty recession.

During that period, the Democrats in Congress has passed massive spending bills.  Those spending bills increased the amount of money in circulation by almost ten percent without a corresponding increased productivity; that is itself disruptive.  The high level of inflation ever since is no coincidence.  The total disregard for the impact on American citizens due to the Democrats’ spending habits is abundantly clear for all to see.

The past six months

The graph for the past six months focuses on the immediate fluctuations of the economy.  During that time, the Fed has increased interest rates, trying to reign in the inflation caused by Congress.  

But higher interest rates increase costs for everyone – businesses and consumers.  The most recent spike in the VIX in late September corresponds with the Fed’s decision to raise interest rates by 0.75%, combined with the announcement that they expect a number of further 0.75% increases in the coming year.  

The Fed’s are actions are considered fairly radical:  either the economy is in pretty deep trouble, or the Fed has made a big mistake.  Neither conclusion is a welcome one.

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An increase of 0.75% is sizeable, and several such increases will in all likelihood result in a period of economic decline.

Don’t blame the Fed; thank the Democrats in Congress and Democrat President Biden.  There seems to be an unspoken battle:  the Democrats spend money that does not exist, causing massive inflation, and the Fed does what it can to repair the economy in the months and years that follow.

Want to end economic convulsions?  Get the Democrats to stop creating money out of thin air, and which, as inflation, is a de facto increase in taxes.  Are the Democrats’ spending programs really worth all that?  They do not seem to care.

Everyone – all of us – would like to have more money to spend on things we would like to have.  But as individuals, we have to be financially responsible – even frugal – and exercise careful budgeting.  Democrats in Congress and the Presidency apparently forget that such careful budgeting still applies to them – even more so, since they are spending taxpayers’ money.  The Democrats give every appearance of believing that your earnings are theirs to take, and spend.  

One analyst made the observation that “corporate profit margins are at risk” and that “60% of the improvement” in stocks since 2008 “resulted from low taxes and low borrowing costs.  Now, both those trends are reversing.”

The VIX graph of the last week of September gives you a solid picture of the volatile economic conditions of the present time.  

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All week long, the VIX has been going up and down like a roller-coaster – and more importantly, the VIX has been steadily in the 30s.  In comparison, the 20-year average is 23.6.  

This means that people are expecting a nasty economic road ahead.  They are spending money to set up protective schemes which they hope will reduce their loss when stock prices continue to drop.

In a single sentence, that tells you as an investor in stocks:  “Go to cash.”  While you should hold on to some of your best stocks – i.e., the stocks of good, solid companies that are likely to survive the recession and come out the strongest (the “bulls” of a bull market) – you might want to sell your more speculative stocks, and hold on to the cash, waiting for the market to bottom out before buying more.  

Until then, do your research.  Study the companies that interest you.  Be ready to buy when the time is right.

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