Wall Street's biggest fear gauge is broken

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CNN Business

Markets are hard to predict right now, and that’s raising a question for some on Wall Street: Does a common measure of volatility actually work the way it should?

Traders don’t have a crystal ball to measure the level of risk when they make investment decisions. Instead they depend on the VIX, or the Chicago Board Options Exchange Volatility Index.

Known as Wall Street’s “fear gauge,” the index is supposed to reflect the market’s estimate of future volatility — or how fast prices will change — 30 days out.

An elevated VIX means increased fear and risk while a low VIX means the market is entering a less stressful period. That’s why the VIX tends to move in the opposite direction of the market.

But as investors churn through increasingly choppy markets, some analysts are worried that this trusted measure of forecasting is broken. The gauge, they say, doesn’t work in an atmosphere heavy with uncertainty, which is when traders most need it.

The VIX is worthless in forecasting the direction of stocks, Aaron Anderson, senior vice president of research at Fisher Investments told me. “There’s just no correlation to future returns. We’ve never understood why so many people accredit so much to the VIX.”

Markets have tumbled over the last four days, bringing the recent late-summer comeback into doubt. The VIX is just now catching up to that, and only sort of.

Digging in: Thirty is considered a high benchmark for the VIX. The index floated around 20 and below — which would indicate less volatility — for most of August. It hit 25 on Wednesday.

In theory, if the index were to predict future market moves, it would have risen that high ahead of last week’s selloff, Scott Bauer, CEO of Prosper Trading Academy who worked for 15 years as a market maker at the CBOE, told me.

Cliff Asness of AQR Capital Management agrees that the index has limited utility: “The VIX tells us almost nothing beyond how much markets have been bouncing around lately,he wrote. In an analysis dating back to the 1990s, he found that the VIX was essentially in line with the S&P 500.

By the time an investor looks back and determines a VIX peak or trough, said analysts at Fisher Investments, they’ve likely already missed the corresponding turn in the S&P 500.

Sometimes there isn’t any connection at all. Fisher analysts pointed to 1995 — a stellar year for markets that had no correlation to the VIX.

The index wasn’t designed to be as useful to retail investors as it is for institutions, said Bauer. There’s a whole cottage industry of derivatives built off it. When the CBOE first created the VIX in 1992, it was intended to be a way for traders to make money by predicting market volatility. It wasn’t supposed to become the major fear gauge it is today.

The bottom line: In uncertain times, we like to cling to any future reassurances that we can, and the financial media certainly likes to use the VIX to that end. But when the unknowns are unknown, the VIX tends to break down.

Bed Bath & Beware

Bed Bath & Beyond had a very bad Wednesday.

The company announced that it will lay off about 20% of corporate employees, close around 150 stores and slash several of its in-house home goods’ brands in a bid to rescue itself from bankruptcy, my colleagues Jordan Valinsky and Nathaniel Meyersohn reported. The retailer announced that it had also managed to secure more than $500 million in financing to shore up its long-term financial problems.

The stock closed down more than 20% lower on the news.

Investor insight: That’s a big shift from recent weeks when the long-ailing company was adopted by so-called meme investors, who use social media platforms to organize large-scale stock purchases. The meme-induced hype lifted Bed Bath and Beyond’s shares from less than $5 at the beginning of August to more than $30 during the middle of the month.

It’s been volatile since then. Shares of BBBY have either been the best or worst-performing stock in the S&P 1500 on nine out of the last 12 trading days, according to an analysis by Bespoke Investment group.

Over on Reddit, meme investors who frequent pages like WallStreetBets appeared confused about what to do next. Some begged fellow Redditors to hold the stock, while others said it was time to let go. But it appears that even meme investors eventually got pulled down with the sinking ship.

The company’s moves on Wednesday were the “prototypical rearranging deck chairs on the Titanic,” said Berna Barshay, an independent retail analyst. The business, she added, is in structural decline.

Bourbon boom

There is one thing investors can be certain of in this increasingly chaotic economic climate: People love to drink.

The bourbon boom is showing no signs of ending anytime soon, reports my CNN Business colleague Paul R. La Monica.

Jack Daniel’s owner Brown-Forman reported quarterly results Wednesday morning that easily topped analysts’ forecasts. Sales were up 11% to $1 billion, and profits surged 30% to $249 million.

Sales of premium, pricier blends of whiskey surged alongside inflation, bucking fears that drinkers would stop shelling out for the good stuff. Old Forester and Woodford Reserve, were up 35% from a year ago.

Brown Forman also said it got a boost from an increase in travel. The spirits company noted that strong demand for booze at airports and on cruise ships also helped lift sales. Revenue from the company’s travel segment, which includes duty-free stores, surged 77% from a year ago.

But the company is not breaking out the champagne glasses (er, whiskey tumblers) just yet. Chief Financial Officer Leanne Cunningham conceded that “we do remain cautious given the potential impact of inflation and rising energy prices on consumer spending” and added that higher prices for commodities will remain a “headwind.”

Up next

Hormel, Campbell Soup, Signet Jewelers and Lululemon report earnings. 

Also today →

▸ US weekly jobless claims

▸ US ISM manufacturing. 

Coming tomorrow: US jobs report 

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