What does Wall Street’s ‘fear gauge’ tell us about future market performance?

Shaun Port


2 min read

Nervousness among investors can spread quickly, damaging confidence and causing markets to drop suddenly. What can one of Wall Street’s fear-factor measures tell us about the volatility we’ve seen recently?

shaun-port

The ‘VIX’ index1 is a well-known barometer for investor fear. When the VIX is low, markets are generally calm, and most likely rising. When this index jumps, it’s a good sign that equity investors have become quite fearful and anxious, and prices are going down.

The VIX index measures the market’s expectation of future (30-day) volatility in the US equity market (S&P 500), using a basket of options prices. The VIX index was created back in 1993, with data going back to 1990.

In the most recent market sell-off, the index has spiked from an average reading of 13 in September to 25 on 11th October, coinciding with a big sell-off in equity markets.  As the chart below shows, VIX has spiked above 20 during significant sell-offs in the US equity market in recent years.

SP-chart

What does a spike in ‘fear’ tell us about the future performance of markets?

After a large spike in VIX, the index typically declines for a few weeks, but then often has another smaller spike, as can be seen in February/March this year and in October. But rather than suggest future losses ahead, jumps in VIX are typically a precursor to future positive performance from stocks.

The table below shows the date when a VIX spike was recorded, followed by comparisons of subsequent stock market performance following the date of the spike in VIX. Typically, over the following month, the stock market performance is quite mixed, but in the following 3-, 6- and 12-month periods, equities tend to produce good gains, except when the US is in a recession. Based on an indicator from the New York Federal Reserve, the probability of a recession in the next 12 months is still low – at about 15% – and as a result, history suggests that high volatility tends to lead to good, rather than bad, equity returns in the future.

VIX-index-spikes

While past performance is never a guarantee of how things will go in the future, history can be helpful in understanding what might happen next and whether or not you should consider making changes.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.

Sources

  1. Chicago Board Options Exchange (CBEO) Volatility Index
Shaun Port

Shaun Port

Shaun is the chief investment officer at Nutmeg. He has over 25 years’ experience developing and implementing investment strategies for clients ranging from central banks to pension schemes to charities and private individuals. Shaun holds a degree in Mathematical Economics from the University of Birmingham and is a Chartered Alternative Investment Analyst. He can be found tweeting @ShaunPort.


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