VIX Premium Forecasts Two More Years for Bear Market ... corresponds with past financial crises

[RedEarth]

Bloomberg reports that traders are increasingly looking to buy longer term downside protection, suggesting that they believe the bear market has another two years to run:

Options investors are paying twice this decade’s average to protect against losses in U.S. stocks through 2011, signaling the bear market that already wiped out $10.4 trillion of equity value may last two more years.

“There’s a real panic in the markets, with some people wanting to buy long-term insurance at any price,” said Peter Sorrentino, who helps manage $16 billion, including $130 million in options at Huntington Asset Advisors Inc. in Cincinnati. “People have lost hope.”....

Two-year volatility dropped 14 percent from its record in November, compared with a 45 percent retreat in 30-day volatility. The difference shows that confidence in the market’s direction over one month has improved while concern about longer- term swings remains elevated, said Paul Britton, chief executive officer of New York-based Capstone Holdings Group, which specializes in volatility trading.

“The market is subdued now because we have enough morphine in our system that we won’t see the spikes we did in October and November,” Britton said. “The uncertainty comes when the medication runs out.”

What is interesting about this two-year time frame is that it puts the duration of the bear market in rough correspondence with what economists Carmen Reinhart and Kenneth Rogoff foresaw in a paper they presented to the AEA, comparing our current crisis to past financial crises. Key metrics:

1. Real housing price declines average over 35% over a six year period. Note in other crises, residential real estate was not necessarily a focus of the bubble. Even excluding Japan (which has suffered a 17 year housing price decline) the average is over 5 years.

2. Equity prices fall 55% over three and a half years.

3. GDP falls an average of 9% (read that twice)

4. Unemployment increases 7% over previous norms.

5. Government debt "explodes", increasing an average of 86%, but the cause is typically not a banking industry recapitalization, but maintaining services in the face of collapsing tax revenues and countercyclical measure ex financial system measures.

http://www.nakedcapitalism.com/2009/03/vix-premium-forecasts-two-more-years.html

[On the Road]

1. Well, in a Sense it "Predicts" That

but a more common use of the VIX is as a contrary indicator.

When the VIX spikes, look for a turnaround.