TLT-VIX: Relation to the Overall Market

There has obviously been a decent amount of worry about what's going on in Europe. If not for our friends across the pond, I think the S&P fundamentally should be trading above 1400 and the market should be creeping higher not lower. That said, for the S&Ps to still be up on the year while Europe gets slaughtered is somewhat impressive. Maybe the market is in better shape than we think and a rally is at hand?

Looking at the stock market and ignoring bonds to determine the health of U.S. markets is a bit like buying a car based on looks alone. If the stock market is the U.S. exterior, the bond markets are the engine that really makes the markets work.

Take a look at this chart. If one were to quickly glance at it, they would think it was CBOE Volatility Index (VIX), since it peaks every time the market drops and craters at market highs.

It is not VIX, it is a 10-year weekly chart of iShares Barclays 20+ Yr Treas.Bond (TLT) through October 31 of last year, the TLT is the ETF that represents long term US debt (more than 20 years to expire). I illustrate this point to show how VIX and bonds are similar instruments. They are both what I would classify as insurance vehicles. The VIX represents that cost of insurance via S&P options, while the bonds are a safe haven investment for banks and funds.

If we zoom in from 2007-October 31 2011, you can see how similar they in movement. What the trader will notice is that typically the VIX moves sooner and in greater magnitude.