VIX – What The Fear Index Is Telling Me

29 Mar

In the last month or two, I have been concerned that index values seemed over stretched across most equity markets in the UK and Internationally. This was coupled with the VIX being at the lowest level we had seen in general terms since June 2007. 

What was interesting was not only were investors being complacent over risk but the media had also followed a similar track. Was risk a past fear? Were we in a low risk low volatility phase where the markets would only enjoy a bullish (optimistic) ever-increasing cycle? Or was risk about to become a concern and the recent equity gains were at risk of being wiped away? – I clearly sit in the second group as I do not believe the economic data, the global and severe woes, financial problems and robustness of investor sentiment could or would sustain.

I believe such a low VIX reading is likely to be troublesome and expect that the next bout of fiscal problems and re-emergence of existing problems will lead the VIX Index and fear to spike, resulting in a drop in equity markets globally. I think a more prudent question is how far will the markets drop?

While not an absolute short-term indicator, lack of publicity of balancing information i.e. both the good and the bad news, I expect will increase the severity when bad news arrives.

I don’t believe the stock rally is over but rather believe volatility will be part of the equation will large market movements both up and down. I think we are currently poised for a drop but how short- or long-term this may be is dependent on sentiment, fundamentals and further economic data.

There are no absolutes in investing, but a low VIX reading has historically been a good equity sell sign. If we consider, April 2011’s VIX lows led to a swift drop of almost 20% across most equity markets (some slightly better and some significantly worse).

The graphs below show two indices – the S&P 500 & the VIX. I think it is clear to see that there is a strong negative relationship. In addition to the VIX’s negative correlation to stocks, the VIX gives a strong indicator to buy/sell signals.

                  

My opinion is we could be at the bottom of the short-term cycle and the market has pulled-back a little recently. I believe there is further to go before markets normalise as the data and fears in the Eurozone, Asia, China, and possibly returns leading to more fear entering the market.

Investing is not a perfect science and so opinions are exactly that so diving from one strategy to another is not wise, sensible or typically profitable. Rather, the strategy should look at type of asset exposure and the expected risk/reward ratio and a suitable portfolio needs to be structured. Yes, over time the portfolio will be biased towards a higher exposure to equities, Gilts & bonds, Property, Commodities and Cash. This will be dependant on market forces, risk profile and investor perspective.

If you want an answer as to when the perfect time to invest this week, ask me next month; and if you want an answer when was the best month to invest this year, ask me next year.

No one has the answer, no one can effectively time the market. The key with investment planning, when one market is over-priced and ripe for a sell-off; another is under-priced and ripe to rocket up. The art is combining assets to minimise the potential to loss making markets with exposure to those with the potential to outperform.

Good Luck with your investment decisions – any questions or further information, email me at welshmoneywiz@virginmedia.com

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