| Six indicators will, collectively, signal that the Bear has | | | | both calls and puts. The VIX is a widely used |
| done her worst: | | | | measure of market risk and is often referred to as |
| 1. The TED Spread - 100% Accurate | | | | the "investor fear gauge |
| This indicator- the yield differential between the | | | | Although the VIX leaps when there is serious trouble |
| front-month 90-day T-Bill and Eurodollar contracts. It | | | | for stocks, it is actually a volatility index, not a |
| has kept its 100% accuracy rating through all the | | | | measure of actual risk. It measures, for traders of |
| financial crises since 1974. | | | | S&P Futures, how wide is the price range of |
| What is it and Why does it work? | | | | options on the S&P. As long as the S&P is |
| The TED spread (i.e. three-month dollar LIBOR less | | | | trading in a +30 range day after day, the stock |
| three-month Treasury Bills) is a measure of perceived | | | | market is still fibrillating, and the patient is not yet |
| credit risk in the economy. This is because T-bills are | | | | ready to go walking in the park with a cane. It needs |
| considered risk-free while LIBOR reflects the credit | | | | to retreat from its manic zone. |
| risk of lending to commercial banks. An increase in | | | | Where is the VIX Today. |
| the TED spread is a sign that lenders believe the risk | | | | It was over 60 when the original article was published |
| of default on interbank loans (also known as counter | | | | On December 26, 2008 the VIX was at 43.38. the |
| party risk) is increasing. On the other hand, when the | | | | decrease in the last few weeks has been an indicator |
| risk of bank defaults is considered to be decreasing, | | | | that a market turn is due. |
| the TED spread narrows. | | | | On January 21, 2009 The VIX Index was 46.42 |
| Since the TED spread's peak of 4.65% on October | | | | That means, it will be time to start buying stocks, if... |
| 10, the measure has eased to 1.46% - a level last | | | | 4. The Yen and the US Dollar Decline |
| seen prior to the Lehman bankruptcy in September | | | | In an Orwellian paradox-Weakness is Strength-the |
| of 2008. | | | | yen and the dollar have outperformed other |
| The TED spread measures risk within the global | | | | currencies. The yen and dollar indices are the |
| banking system. Eurodollars are the primary | | | | currencies in which debt is denominated. They have |
| instrument of inter-bank lending-unregulated and | | | | been elevated sharply due to the deleveraging |
| uninsured dollars. Therefore, the spread over T-Bills | | | | process; as US investors sell assets outside the US |
| reflects bankers' pricing of the risk in short-term loans | | | | and repay debts inside the US, the dollar rises. The |
| to each other. It ALWAYS spikes in advance of a | | | | yen, as the instrument of the carry trade, suffers |
| financial crisis. It ALWAYS falls when the crisis is past. | | | | the same ignoble boost. By outperforming Eurodollars, |
| It has become even more sensitive over the years | | | | pounds and other major currencies, they have been |
| as the banking system has become more globalized | | | | giving warning signals. They should revert to |
| and network-driven. Serious banking problems | | | | normalcy, and turn negative, when the distress sales |
| anywhere in the system can be enough to produce a | | | | of hedge fund assets and of bankrupt assets have |
| flicker-or worse. In 1984, on the day Continental | | | | dwindled. |
| Illinois went down, the Fed's onsite manager called | | | | When all four indicators have confirmed STOCKS |
| Paul Volcker before 5 a.m. to tell him that the TED | | | | WILL RISE. |
| had opened at 415. That was enough to send all the | | | | Addendum: January 2009 |
| Fed's emergency operations into action. They swiftly | | | | Two additional indicators for your due diligence: |
| checked with the eight biggest banks and found the | | | | 5. Bank Lending LIBOR - OIS |
| trouble spot-the Continental Illinois. By 11 a.m., the Fed | | | | The difference between the LIBOR rate and the |
| had bailed it out, using the FDIC (Federal Deposit | | | | overnight index swap (OIS) rate is another measure |
| Insurance Corporation) Fund to pay off the Japanese | | | | of credit market stress. |
| banks' wholesale Eurodollar deposits that they were | | | | When the LIBOR-OIS spread increases, it indicates |
| unwilling to roll over. (That may have been the | | | | that banks believe the other banks they are lending |
| largest-scale illegal act of a US public servant in | | | | to have a higher risk of defaulting on the loans, so |
| history: the FDIC Fund had a $100,000 limit per | | | | they charge a higher interest rate to offset that risk. |
| deposit and it was limited to domestic depositors. | | | | The opposite applies to a narrowing LIBOR-OIS |
| Sometimes, a Fed Chairman's does.) The TED peaked | | | | spread. |
| around 500 when Lehman collapsed and broke 200 | | | | Similar to the TED spread, the narrowing in the |
| last Friday. It is currently 197. We suspect that if it | | | | LIBOR-OIS spread over the past few weeks is also |
| breaks 150 and stays there for at least a week, the | | | | a move in the right direction |
| financial crisis part of this drama, while not humdrum, | | | | The Libor USD 3M Rate was 1.12 on January 21,2009 |
| will no longer command center stage. That means, it | | | | 6. KBW Bank Sector Index |
| will be time to start buying stocks, if... | | | | As a general rule investors look to the financial sector |
| Update: Where is the Ted Spread Today | | | | to lead the market recovery. The KBW Index is used |
| On December 26,2008 The Ted Spread had fallen | | | | to track the performance of banks. The 2008 |
| (further) to 1.48 - a trend that indicates the stock | | | | continuing financial crisis saw a dramatic drop in this |
| market is bottoming and moving to an upturn. | | | | index and therefore a sustained rise will foretell a |
| On January , 21 2009 The Ted Spread had fallen to | | | | stock market turn. |
| 1.02 | | | | The index was created and is traded by the |
| 2. The Bank Stock Index continues to outperform | | | | Philadelphia Stock Exchange. It also is referred to as |
| the S&P | | | | the bank index, or BK, which is its trading symbol. |
| Since the Midnight Massacre, the BKX has been | | | | The BKX is a capitalization-weighted index composed |
| outperforming the S&P on a relative basis, for | | | | of 24 geographically diverse stocks representing |
| more than the requisite six weeks. That means, it will | | | | national money center banks and leading regional |
| be time to start buying stocks, if... | | | | institutions. BKX is based on one-tenth of the value |
| 3. The VIX (FEAR INDEX) Retreats | | | | of the Keefe, Bruyette & Woods Index (KBWI). |
| The VIX is more properly identified as the CBOE | | | | Founded in 1962, Keefe, Bruyette & Woods is |
| Volatility Index. | | | | recognized as a banking industry authority. The index |
| The ticker symbol is for the Chicago Board Options | | | | was initiated at the time of the firm's founding and |
| Exchange (CBOE) Volatility Index, which shows the | | | | was calculated retroactively to 1947. The index is |
| market's expectation of 30-day volatility. It is | | | | evaluated at least annually by Keefe, Bruyette & |
| constructed using the implied volatilities of a wide | | | | Woods to assure that the composition is highly |
| range of S&P 500 index options. This volatility is | | | | representative of the banking industry. |
| meant to be forward looking and is calculated from | | | | |