marketplace investment
20 finweek 19 March 2020 http://www.fin24.com/finweekMARKETS
a
s I was writing this, we were just entering the month
of March, following a February filled with so much
negativity that I’m sure we would all just like to forget
it as soon as possible.
They say that it is always the darkest before the dawn, and
although this may not be the answer that investors are looking
for, it is the best advice in terms of what not necessarily to do
right now.
Sometimes it is better to listen to that worried little voice in
your head warning you not to follow the herd. Make no mistake,
I’m not saying that the worst is over. What I’m suggesting is that
you should look at the past and how history can help you to think
twice before you sell everything because you’re panicking.
A great tool to use in times of high volatility, is the volatility
ratio (VR). Every time the volatility index (VIX) of the Chicago
Board Options Exchange (CBOE) moved to levels of above 40, it
was the greatest opportunity to buy in the market — ever.
It stayed that way until it moved back to levels of around
10, which normally acts as an indicator that the market is
starting to turn.
Before I continue, however, I would like to explain how
investors can use volatility not only to determine risk,
but also to point out possible investment opportunities
and dangers. Volatility is not a directional indicator, but
rather a measure used to express changes in pricing as a
percentage.
If share A’s price rises from 100c to 101c, it indicates a
positive change of 1%. If share B’s price moves from 200c
to 198c, it is seen as a negative change of 1%. The VR of
both shares is the same (1%), therefore the VR of share A
is equal to that of share B.
The VR can be used to determine the risk of a
particular investment. When an investment in a share, for
example, has a VR of 20, it means that the investment
has already moved up or down by 20% during the period
in question. This means that if you do decide to buy this share,
you don’t only have an opportunity to grow your investment
by 20%, you also risk losing 20% of its value. The lower the VR,
therefore, the lower the risk. Or so it seems.
What this tells us, is that emotions play a massive role in
the decision-making process during times of high volatility, and
investors then have the tendency to force the market to levels
well below its fair value. In times of low volatility, on the other
hand, investors are so confident that the market will not drop to
lower levels that they force it upwards.
The US stock market has always been considered as being in
completely oversold territory when the VR reaches levels above
40, while it is considered as saturated when it moves closer to 10.
Until recently, we have seen the VIX trading at levels of
around 10% on a regular basis and investors simply refused to
believe that the S&P 500 Index could experience a decline. TheKnow the risk you’re taking on
History has shown us that volatile markets may calm down and deliver solid returns afterwards. Schalk Louw
analyses an important index that measures these swings.coronavirus (Covid-19) outbreak, however, has brought
this gravy train to an abrupt halt, and it’s not just causing
world markets to crash, but also the US market. The
S&P 500 has declined by 13%, in just the two weeks
between 14 and 28 February 2020. And so, for the first
time since September 2011, the VIX has closed above 40%
at month-end (see graph).
Don’t get me wrong, I’m not calling the past month’s
events nothing to worry about. Clearly the uncertainty
factor is still extremely high in stock markets. But
historical data is showing us that now is the time to
remain cool, calm and collected. Since 1992, we have
only seen the VIX close month-end at above 40% a total
of eight times. These included, among others, a massive
market collapse in 1998, the build-up to the war in Iraq
at the end of 2002, and the Great Recession and market
collapse of 2008.
In each of the eight instances where the VIX measured
above 40%, it was backed by good reasons. However, were
any of these reasons good enough to sell your shares? Most
definitely not.
The S&P 500 delivered the following average returns over the
following periods after each of the eight occurrences: six-month
returns of 20.5%, one-year returns of 30.9%, and two-year
returns of 50.6%.
As mentioned before, investors shouldn’t use the VR as a
directional indicator, but rather to determine risk and a possible
overreaction to market events.
It doesn’t matter how you use the stock market to invest
as long as you make sure that you have done your homework
properly and that if you decide to follow the herd, you don’t bite
off more risk than you can chew. ■
[email protected]
Schalk Louw is a portfolio manager at PSG Wealth.When an investment in a share,
for example, has a VR of20
it means that the investment has
already moved up or down by20%
during the period in question.SOURCE: Thomson Reuters/Refinitiv and PSG Wealth Old OakOne standard deviation above average Average One standard deviation below averageBy Schalk LouwCBOE VOLATILITY INDEX: VIX
70.0060.00
50.0040.00
30.0020.00
10.000.00
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