Tuesday 3 March 2020 11:25 am Schroders Talk

How does the stock market perform when the VIX fear gauge surges?

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I am head of research and analytics at Schroders.

The spread of the coronavirus has sent shock waves through global stock markets.

Alongside plummeting share prices, the VIX index, the market’s so-called fear gauge, has shot up.

At the time of writing, on 28 February, it stands at over 40.

This is very high compared to long-term norms. Since 1990, it has averaged 19 and as recently as mid-February it stood at only 14.

The VIX reflects the amount of volatility traders expect for the US’ S&P 500 stock market index during the next 30 days.

No one can say for certain how the spread of the coronavirus will evolve, but we can look at how stock markets have performed in the past during periods of heightened fear.

The emotional response to such situations is to sell. Historically, however, this would have been the wrong thing to do.

The chart below shows how the S&P 500 has performed when the VIX has been in different percentiles of its history.

For example, 5% of the time the VIX has been below 11.3 and 5% of the time it has been between 11.3 and 11.9, and so on. This breakdown allows us to derive the most meaningful data.

The current reading of over 40 puts the VIX in the top bracket of historical experience.

However, rather than being an opportune time to sell, historically this has been when the best returns have been earned – for the brave hearted.

On average, the S&P 500 has generated a return of over 25% in the 12 months after the VIX breached 32.9.

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Next 12 month S&P 500 return based on different starting VIX

Each range corresponds to 5% of historic experience for the VIX

Furthermore, a strategy which sold out of stocks (S&P 500) and went into cash on a daily basis whenever the VIX entered this top bucket, then shifted back into stocks whenever it dipped back below, would have underperformed a strategy which remained continually invested in stocks by 2.5% a year since 1991 (6.7% a year vs 9.2% a year, ignoring any costs).

A $100 investment in the fully invested portfolio in January 1990 would have grown to be worth more than twice as much as $100 invested in the switching portfolio. 

As with all investment, the past is not necessarily a guide to the future but history suggests that periods of heightened fear, as we are experiencing in at present, have been better for stock market investing than might have been expected.

Important Information: The views and opinions contained herein are of those named in the article and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This communication is marketing material.

This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 1 London Wall Place, London, EC2Y 5AU. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.

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