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False Positives

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Is it better to believe some things that are false, or to disbelieve some things that are true? These days, every market watcher has an indicator to show you, some chart pattern or statistical threshold that predicted four of the last five market turns and just so happens to be flashing a warning sign right now. Value investors are still talking about CAPE ratios and NYSE margin debt; straight-up technical analysts have been drowning in superfluous indicators for years; and now, even we options traders have our share of over-burdened indexes.

These are all valuable in different ways, but not necessarily in the predictive roles into which they get shoehorned in broad market commentary:

- CBOE Volatility Index (VIX): At 13, it isn't "too low" or "a sign of complacency." With SPX one month realized volatility at 9.4%, a 13% VIX is actually kind of high. If you were buying a house with a 9% chance of flooding, would you consider flood insurance priced at an implied rate of 13% a screaming buy?

- VIX put/call ratio: This ratio came up in the media this week, but as I showed in an article last year, the volume of VIX put and call trading has not been a meaningful predictor of subsequent S&P 500 returns.

- SKEW: We looked a few weeks ago at the high levels of S&P 500 implied volatility skew. Bearish Zero Hedge types were hyping those levels for weeks as a portent of a big correction. But as we saw, even limited to high readings, SKEW wasn't predictive of next-month market returns.

I'd rather believe too few truths than believe many falsehoods, at least where markets are concerned, since the history of truth-telling market factors is also the history of their weakening predictive power. Or in more practical terms, since our attention and other resources are finite, it's better to focus those limited resources monitoring the market signals that really matter, instead of flitting back and forth among unproven indicators.

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At the time of publication, Jared Woodard held positions in SPX, VIX.


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