Getting the Market Right: Eric Fry on How to Read the VIX Volatility Index
Editor’s Note: This episode was recorded right after the correction earlier this month, when the Volatility Index (VIX) was at multiyear highs. Volatility has come down somewhat since then (although it’s still above its 2017 lows). So the references in this video to “last week’s” volatility spike are outdated by a few days.
Nonetheless, Eric’s insights about volatility and the market cycle will never be out of date. We hope you enjoy this informative interview.
Steve McDonald (SM): Our guest this week is Eric Fry of Fry’s Pinnacle Portfolio – the award-winning Eric Fry. He came in first in the nationwide stock picking contest called Portfolios with Purpose, didn’t you?
Eric Fry (EF): That’s correct, in 2016.
SM: Yeah, what was your total return?
SM: Not bad.
The topic today, as most people might imagine after the week we had last week, is volatility. Do you look at volatility when you pick stocks?
EF: I look at a lot of macroeconomic indicators, volatility being one of them.
You’re trying to gauge opportune moments to enter and exit a trade, and so the volatility reading – the VIX, as most people know it – is an indicator of relative market complacency or fear. It’s called the “fear gauge.”
SM: Yeah, I’d say we were a little complacent until about a week ago.
EF: Well, as recently as the first week of January, the VIX hit its lowest reading of its entire 26-year history.
SM: Was it 11 or something?
EF: Yeah, it was below 11.
SM: Wow, I didn’t know it got that low.
EF: And by itself, it’s not a very good timing indicator. It’s just an indicator of where you are emotionally or psychologically in the stock market.
And when you overlay that kind of a reading with what, on many valuation metrics, were all-time high valuations in the stock market, then you get kind of a dicey scenario.
And I actually wrote two columns about it in January, saying that we were in a dangerous area.
SM: You say it’s a measure of complacency… What happens if it hits 50?
EF: That’s a measure of fear. That’s the antonym. That’s the opposite of complacency. That’s why it’s called the fear gauge.
The VIX goes up as a measure of options pricing. Options prices go up when people are buying options to protect themselves. That causes the VIX to spike.
And it has gone up about 200% in the last week or so.
SM: I take it you don’t rely on the VIX.
EF: Not as a timing indicator, but it’s a valuable indicator of where we are in a market cycle.
One of the columns I wrote was about the VIX ETFs or ETNs – the stocks that track readings of the VIX.
Now, those things have doubled or tripled in the last few trading days.
However, they have been terrible investments for the last five or six years because there has been no volatility. The market has been going up and so these things have been going down.
So it’s not a very effective way to hedge your portfolio.
SM: What do you look at for hedging right now? What do you use?
EF: Unless you are truly a hedge fund, and unless you’re looking to generate alpha from your short sales, the average investor can’t really hedge. They have to make this binary choice between being in stocks or cash. And there’s also real estate.
So as a hedging technique, when we get very, very volatile markets like this – and really it applies to all markets – you want to be looking at your investment time frame. Is it one year? Is it 30 years?
If it’s one year, then a market like the one we’re in right now gives you every reason to be concerned. And you might want to pull back.
If your time frame is 10 years or 20 years, then how do you hedge?
You hedge by investing over time. You hedge by not putting all your eggs in one basket. You allocate some now… some in three months… some in six months. You use dollar-cost averaging.
SM: For eight years, Obama’s Fed tried to get inflation going. Now, suddenly, inflation is in the news.
EF: It’s certainly popping up. We’ve had inflation in stock prices – that’s the good kind of inflation. People like that.
Whether we get classic inflation or not, I don’t know. What I do know is that we’re certainly seeing bond yields rising, meaning bond prices are falling.
SM: And when you say “bonds” do you mean “Treasurys”?
EF: I mean across the entire credit spectrum. Anything from Treasurys down to high-yield. All of those instruments are – in general – falling in price, and yields are rising.
A rising-rate environment is not typically an ideal scenario for the stock market. That’s another reason why you want to invest over time.
But again, I don’t think it’s a reason to PANIC in big capital letters… just panic a little.
SM: So I guess that’s the advice for this week – panic a little, not a lot. Thanks so much for being with us.
EF: Thank you.
P.S. To learn more about how Eric Fry generates huge returns by tracking the market cycle, check out Fry’s Pinnacle Portfolio.
About Steve McDonald
Somewhat of a renaissance man, Steve worked as a professional broker and has been an active trader of bonds for more than two decades, specializing in ultra-short-maturity corporate bonds. But before entering the investment industry, Steve was a naval aviator, flying fixed-and rotary-winged aircrafts, and also served as a surface warfare officer. Steve’s regular video series featured on Wealthy Retirement called “Slap in the Face” Award is some the most amusing investment content we republish.