Credit Spreads are not Confirming the VIX

The VIX currently has a 12 handle and appears to be getting ready to break back down to levels not seen since before the financial crisis.  Prior to 2007 the VIX was quoted in a more narrow range at a lower level than its recent range.  In 2007 there was a structural break and the VIX rose as risk appetite collapsed.  Now for the first time since 2005-2006, the VIX is approaching old levels.  To many this could signal that risk appetite has returned to pre-crisis levels.

Investment grade credit spreads display a similar structural break to the VIX beginning in mid 2007, but the VIX's recent decline to previous lows has not been matched by a tightening of credit spreads.  While that might suggest that the VIX isn't telling the full story on risk appetite, it's tough to say which indicator gives a clearer picture because all in yields are much lower than they were in 2006 even if spreads have not completely compressed.

Data via FRED

Jobless Claims, the VIX and High Yield Spreads

Initial jobless claims were reported today and fell back towards their lowest levels for this cycle at 359k.  The chart looks similar to two other important financial charts: the VIX and High Yield credit spreads.  All three charts show a similar spike in the recession and have gradually declined since (with some bumps along the way).  Now all three are settling at low levels, but slightly higher than their lowest points reached in 2006/2007.  If the S&P 500 is going to extend its rally from here, it would seem dependent on each of these indicators breaking through to lower levels.  Can we get there?

How Good is the VIX at Forecasting Future Volatility?

UPDATE: There was an error in the way I annualized the VIX in the original post leading to a different conclusion.  The error should have been corrected below.

According to those who believe in efficient markets, market based prices should be reliable indicators of future events.  If the efficient market hypothesis holds true, then the VIX should be a reliable predictor of future stock market volatility.  Is it?

The VIX is supposed to forecast the 30 day future volatility of the S&P 500.  Below is a chart of the VIX against a chart of the actual realized volatility 30 days from the time of measurement of the VIX.  On average, the VIX has expected a slightly more volatile environment than has been realized over the last 8 years.  The average difference between the VIX and actual volatility in this period was about 3.25%.

How Much has Volatility Fallen?

As the VIX has fallen to multi-year lows over the past several trading sessions, the S&P 500 continues to trade in a very narrow daily range.  The average daily (absolute value) change in the S&P 500 is nearing lows of its own at +/- 0.55%.

Although the VIX is supposed to be a forward looking indicator, it is highly correlated with recent history.  It rises and falls in lockstep with what has happened over the previous 30 days.