Tuesday, May 8, 2007

Technical Tuesdays: What’s With the VIX?

Under the radar and out of the discussion of late, but as noted in a prior comment, the VIX has settled into a trading range approximately 30% higher than previous bottoming levels (see 3 year chart to the left). What is the significance of its elevated trading range? One possible answer lies in the increased fragmentation of market size and styles.

An interesting pattern has emerged over the past year in which the performance of style segments within market caps are widening. For example, for several years small cap growth and small cap value have tracked very closely to one another (see chart to the left). However, beginning last spring, the performance patterns have changed with small cap growth outperforming small cap value. The same is true in the mid cap area – only the reverse is true: mid cap value has begun to outperform mid cap growth.

Investment Strategy Implications

I have argued in recent television appearances that we have likely entered a market period where size and style selection will matter more than it has in the recent past. The performance data bears that out. And with it is an elevated level of the VIX implying that the homogenization of market returns has ended and in its place is greater performance diversity, higher uncertainty, and, therefore, greater risk. Correlations are still high but I would suspect that they are about to change as well.

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