Does low volatility mean a shock lies in store for investors?
Stock markets perform better than you might expect when the market’s “fear gauge” is subdued.
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Despite the many viral, economic, and geopolitical risks in the world today, volatility in asset markets has fallen to remarkably subdued levels.
The VIX Index, the market’s so-called fear gauge, has recently fallen to a reading of around 16. This is below the average since 1991 of 19.
The VIX reflects the amount of volatility traders expect for the US’ S&P 500 stock market index during the next 30 days.
The recent calm in the markets has raised alarm bells among some investors amid concerns of complacency.
However, when we look back over time, investors would have been unwise to sell stocks purely on the basis of a low VIX reading.
The chart shows how the S&P 500 has performed when the VIX has been in different historical ranges. Each range has been set to cover 5% of the VIX’s experience. For example, 5% of the time the VIX has been below 11.3, 5% of the time it has been between 11.3 and 12.0, and so on. This breakdown allows us to derive the most meaningful data.
On average, the S&P 500 has generated a return of around 15% in the 12 months following a VIX reading of 16.
Rather than being an opportune time to sell, historically this has been when pretty good returns have been earned.
Conversely, the worst time to buy has actually been when the VIX has been relatively high. Typically, the VIX spikes when markets are falling. When the VIX has been in the 20s, the knife has still been falling and investors who bought then have cut themselves.
It is only when investors turn hysterical – when the VIX has been around 30 or higher – that the best returns have been earned by the brave hearted. What happened last year is a case in point. The old adage that investors should be greedy when others are fearful shines through clearly here.
As with all investment, the past is not necessarily a guide to the future but history suggests that investors would be unwise to make their investing decisions purely on the basis of subdued levels of volatility.
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Past performance is not a guide to future performance and may not be repeated.
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