Hajime Kitano, head of JPMorgan’s Japanese equity strategy, always has an interesting way of seeing things – especially when he’s looking at the VIX, an index measuring stock market volatility.
In his latest note to clients, Kitano says that if the VIX stays subdued near current levels next week, it will mark a “phase change” for markets – a transition from a period of crisis into “normal time.”
Kitano writes that it’s been exactly three months since the “darkest day this year,” on July 24. 10-year U.S. Treasuries hit their lowest yields of the year at 1.39 per cent that day, and 10-year Spanish bonos hit their highest, at 7.62 per cent.
Now, three months later, the VIX is the last of the three indicators to confirm that markets have moved from “crisis” to “normal time.”
From Kitano’s note:
If the VIX index remains at its current level (16.6) next week, furthermore, its 52-week moving average will fall below the July 2011 level to its lowest point since February 2008. Figure 1 shows the relationship between the VIX index’s long-term average (20.3 since 1990) and its 52-week moving average. We think this illustrates how its level varies between normal times and crises. If the VIX index’s 52-week moving average falls below the long-term average (20.3) and the most recent low (19.1 in July 2011) this time, we think it will suggest a change of phase from crisis to normality.
The last time the phase changed from crisis to normality was in February 2004. U.S. interest rates started to rise on June 30, 2004…The economic ‘bottom’ at that time was November 2001 in the U.S. and January 2002 in Japan. It was 27 months from the U.S. economic bottom (November 2001) to the phase change (February 2004). This time, the current month is the 40th since the economic bottom (June 2009). The aforementioned July 2011 would have represented the same duration as in the previous cycle, but the European credit crisis caused a year’s delay, as we see it.
However, the other two “yardsticks” Kitano uses to measure crisis versus normal time – those related to the European credit crisis – are already signaling normality and are just waiting on the VIX.
European credit spreads have fallen below 4 per cent. The 2-year U.S. Treasury yield has risen above 0.3 per cent. The VIX just needs to make its transition into normal phase.
None of this is to say that things are moving back into “normal time” for those unemployed or otherwise put out by the crisis.
In market circles, though, this is a theme that’s been gathering attention in recent months. The reflation trade appears to be back, for now.