Sent: 23-08-2011 13:58:03
In this issue:
Return to full article list
HomeFree weekly newsletterSelf Managed Super Fund ArticlesContact usLogin
If Not the End of the World, an Opportunity!
There will be an end of the world but, if this isn't it, extreme market volatility has a silver lining. History says you should now be invested.
The huge intraday swings in equity markets that grabbed the headlines last week pushed the Chicago Board Options Exchange volatility index, commonly referred to as the VIX, to levels that had only been reached six times in the past 15 years.
The so-called fear gauge measures the volatility implied by equity index options traded on the Chicago exchange.
The chart at http://www.thebigpicture.com.au/atc/vix.pdf shows the daily closing VIX values since 1995. There have been six prior events during which the VIX closed at or above the level at which it closed on Friday.
- The Asian financial crisis in 1997
- The Russian financial crisis, collapse of LTCM and ensuing Fed bailout of creditors in 1998.
- The bursting of the .com bubble and subsequent business closures in 2001.
- The collapse of Enron and WorldCom in 2002 and the accompanying audit and accounting scandals.
- The failure of north Atlantic banks and the collapse of investment banking lines of credit in the USA in 2008.
- The European sovereign debt crisis in 2010.
As the fear associated with these events and measured by the VIX subsided, markets regained some composure and posted large gains in the months immediately after displaying their greatest anxiety.
The table below shows gains made by the S&P500 index during the four months after the peak value in the VIX had been hit. With the exception of the period associated with the European debt crisis, the market made a double digit gain in each instance within the following four months.
|Asian financial crisis||+13.4%|
|Russian financial crisis||+29.5%|
|.com bubble bursting||+13.5%|
|Failure of Enron and WorldCom||+19.6%|
|North Atlantic banking failure||+15.9%|
|European sovereign debt crisis||+6.6%|
The 6.6% gain within four months of the VIX hitting its peak response to the European debt crisis was relatively modest. However, within seven months of the VIX hitting its peak, the market had risen by 16% and by 25% after 12 months.
Apparently, when the fear of further market losses is at its greatest, the potential returns from investing are at their greatest, too.
Conversely, quitting when the fear is greatest probably removes the best chance of recouping losses that had been made while the market had been weakening.
Of course, there is a risk in looking at markets in this way. As we saw in 2008, market anxiety reached unparalleled levels before relative calm was restored. In that case, extrapolating the rise in the VIX past the previous peaks before buying into the market once again would have made sense.
In short, these are investment markets so there are no foolproof paths to riches. Nonetheless, history says that we should not be afraid of fear. Significant market volatility offers opportunities that are not otherwise available. Now for the test: will it happen again?
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.