Expected Next 30-Day Volatility Is Still Well Above The Non-Crisis Level

One simple way to translate the VIX index (^VIX: 27.95 +1.73 +6.60%) into an easy to understand monthly implied volatility is employing the following equation:

Next Month Expected Volatility = VIX/100/sqrt(12)

The result simply says that over the 30-day period, the SP500 is expected to have a volatility of plus/minus a given percentage.

The following graph shows the historical next 30-day expected volatility from 1990 to 2009. This does reflect the change in VIX calculation method that was instituted in 2003.

The simple historical average of the 1-month expected volatility for last 19 years is at 5.827%. Rising above this level usually represents some kind of turmoil and crisis. Examples include:

1.  Gulf War in the early 90s.

2.  Long Term Capital Management (LTCM) in 1998

3.  2000 tech bubble burst

4.  Sep 11th terrorist attack

5. Inital subprime mortgage crisis

6. Collapse of Bear Stearns

7. Collapse of Lehman/AIG and the following financial and economic collapse

Thus, until the expected monthly volatility of the SP500 goes below its historical average of 5.827% for a sustained period of time, all we can say is that the market simply is taking a break from its primary trend.

I hear a lot of people are still expecting the SP500 to go to 1000 and above. I am not saying that is not a possibility but taking such a position at this point is fairly dangerous. We have to ask ourselves “Is the economic climate improved?” The answer is simply no. Deceleration of economic decline does not translate into economic improvement. I continue to remind people that the current recession has been over 18 months now surpassing all previous recessions and there is still no clear end in sight. If the economy does not pull itself out in the next 6-12 months, we are likely heading towards the 2nd Depression defined as a prolonged period of recession lasting more than two to three years.