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The attached chart shows a composite index which averages the 20-day log
volatility of four separate indices:
1) the US Dollar Index
2) the price of gold (in US$)
3) the interest rate on the 10 year US Treasury Note
3) the price of the NDX 100
Each volatility measure is annulized (for example, the NDX volatility ranged
from about 35% to 75% per annum), and they're weighted in proportion to an
approximation of their longer term average levels:
3 * VOL(USD) + 1.5 VOL(T10Y) + VOL(GOLD) + 0.5 * VOL(NDX)
The resulting index values range between roughly 40 on low side and 90 on the
high side.
In composing this index, I thought there might be some information to be gained
about the the overall market's level of uncertainty - if we view the volatility
of prices as a measure of uncertainty. Looking over the chart, we can pick off
a few points of low uncertainty (perhaps complacency):
8/26/1998 (40.91) - the economy was hitting on all cylinders, and the "Asian
contagion" was just ahead
8/30/2000 (49.84) - the stock market had come back strongly and looked like it
might challenge the March 2000 top.
8/07/2001 (54.66) - the economy looked like it was trying to scratch and claw
its way back, and stage a recovery.
(interesting observation - all three low points were in the month of August -
this is generally a seasonal period of low volatility any way.)
The times of high uncertainty/volatility were:
10/12/1998 (86.68) - the crash in the Asian markets had hit in full force.
10/06/1999 (81.45) - LTCM
02/07/2000 (86.27) - not quite the top of the Nasdaq frenzy, but close
06/19/2000 (89.01)
01/05/2001 (87.10)
04/23/2001 (90.75) Intermediate term bottom in the Nasdaq
09/24/2001 (82.56) Sept. 11 aftermath
The current level of the uncertainty index is 57.48, which is on the low side
of its typical range, but not at an extremely low level that would be typical
of a market top. Looking at the other charts for periods before 1998, it seems
that 1994 marked another high in volatility, and market bottom, but the low
volatility registered 1995 would've been a head fake, if used as an indication
of a market top.
Note that this index was not put together in any sort of scientific fashion,
and that in general the volatilies of the indices chosen are often correlated.
Still, perhaps when viewed as a method for judging extreme high and low levels
of uncertainty/complacency in the market, it has some use.
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