Economists gone wild

My friend Bill, who is himself an economist and a good one (and who does not try to predict stock market movements) sent me the following link to something put out by a couple of Stanford economists which is one of the more ridiculous things I have seen in this cycle.

http://www.voxeu.org/index.php?q=node/2785

Basically, these two guys postulate that "uncertainty is now falling" and use as evidence of that the fall in the VIX from its spectacular heights of October/November to a much lower number. There are, however, a number of serious flaws in their argument.

First, while they are correct that the VIX is down by 50% (or was when they wrote the piece in late January...it has now gone up again) it is still very high by historical standards. It is presently at a level that is roughly equal to the worst of any previous economic crisis in living memory. While it is an improvement, true, it can hardly be heralded as the end of uncertainty.

There is no demonstrated correlation between the level of VIX and the direction of stock market movements. If everyone (correctly or incorrectly) believes the stock market will move down, then the VIX will be quite low. Where there is consensus, the VIX is low. The VIX rises to high levels only when the consensus proves to be terribly wrong (as in October 2008 or October 1987 -- AFTER the crash).

The VIX says nothing about the economy, only about implied stock market volatility. There is nothing to suggest that consumer spending or corporate earnings is going to improve meaningfully or that the unemployment news is going to show any improvement. With no major improvements in employment, earnings, or consumer confidence, there is not going to be much improvement in stock market levels, VIX or no VIX.