Time to check out the fear index

When Franklin Delano Roosevelt was inaugurated in 1933, America was battling the effects of the Great Depression and the country’s thirty-second president attempted to rally Americans round by declaring that “The only thing to fear is fear itself”.

In the narrow context of financial markets, this column does wonder whether there can be more than a grain of truth in that, especially as broader sentiment has switched from greed to fear in less than two months. Indeed, it has taken the FTSE All-Share just 52 calendar days to fall by more than 20% from its January high and tumble into bear market territory.

Ultimately, no one has a crystal ball and advisers and clients are left weighing up probabilities. This can be done via valuation and also – in a crude, short-hand form – via the VIX index. The so-called ‘fear index’, which can be tracked for free via the internet, measures expected future volatility in the stock market (there is a UK equivalent but the US version has a longer trading history, so this column will focus on the US this week).

“The VIX was launched in 1990 and it has averaged a reading of 19 over its history, with a low of 9.1 in November 2017 and a high of 80.86 in November 2008.”


The VIX was launched in 1990 and it has averaged a reading of 19 over its history, with a low of 9.1 in November 2017 and a high of 80.86 in November 2008. (In fact, the 30 highest VIX readings ever all date from 2008 when the Great Financial Crisis reached its zenith.)

The eagle-eyed will immediately note that the VIX hit a low as a bull market was in full flow and reached a peak as bears were in charge and share prices were collapsing in the wake of Lehman Brothers’ collapse.

On other words, it is tempting to think that the VIX may be more useful as a contrarian indicator than as a lead indicator – after all, to repeat one of this column’s favourite mantras from Warren Buffett, investors should look to be “fearful when others are greedy and greedy when others are fearful”.

Panic button

“At the time of writing, the VIX has just jumped to a reading of 58.75, within the highest 1% of all VIX readings since 1990, so everyone seems pretty frightened.”


At the time of writing, the VIX has just jumped to a reading of 58.75, within the highest 1% of all VIX readings since 1990, so everyone seems pretty frightened. This begs the question of whether now is the time to panic along with everyone else and run for cover, or to be contrarian and start to research possible purchases.

VIX has spiked to its highest mark since December 2008

Source: Refinitiv data

This column has looked at the fear index’s history and it has moved above 40 – more than twice its historic average – just 12 times, including this week. It should therefore be instructive be look at how the S&P 500 has performed ahead of such spikes in the VIX and then how it has fared after them.

“Analysis of how the VIX performed in the run-up to a move above that 40 mark shows that markets have already begun to fall and fall hard by the time fear really takes over.”


Analysis of how the VIX performed in the run-up to a move above that 40 mark shows that markets have already begun to fall and fall hard by the time fear really takes over. Note how the S&P 500 lost more than a fifth of its value in the six months preceding a reading of 40 four times out of twelve. In fact, what it odd about the two such occasions this year is how calm markets were beforehand, perhaps because the viral outbreak was just impossible to forecast.

Note also how markets tend to rally after the VIX hits 40, to again support the thesis that it is a contrarian indicator and back up Buffett’s aphorism. Indeed, after a move above 40, the VIX tends to peak on average barely 20 days later, suggesting that, by the time the VIX hits this mark, the worst may already be behind us.

Markets tend to have already fallen as the VIX hits 40 and rally after

Source: Refinitiv data

Cape Fear

“After a move above 40, the VIX tends to peak on average barely 20 days later, suggesting that, by the time the VIX hits this mark, the worst may already be behind us. However, as with any trend, there are [two big] exceptions to the rule.”


However, as with any trend, there are exceptions to the rule. The S&P was lower still 12 months after the 40 mark was crossed in 2001 as the tech bubble burst, and again 12 months after it got there in September 2008. In both cases, there were two factors at play:

  • a lengthy recession; and

  • valuations that peaked at historically lofty levels.

  • The first of those two preconditions for an extended period of volatility and further market drops remains open to question now, although it is clearly what investors currently fear. The second, unfortunately, was very much in place, using the cyclically-adjusted price earnings (CAPE) ratio devised by Professor Robert Shiller. Before the latest sell-off, the CAPE multiple of 31.5 times had only been exceeded twice in the S&P 500’s history – 1929 and 2000 – and neither of those periods ended well at all.

    It is tempting to think that the VIX is telling us that investors have panicked thanks to the unknown threat to economic activity posed by the COVID-19 outbreak and noise created by the collapse in oil prices, and that markets are oversold as a result. However, the valuation starting point was so extreme in the US, a slide into recession could still leave the S&P 500 exposed so investors will need to keep a close eye on macroeconomic data and company news flow in the coming weeks and months.

    AJ Bell Investment Director

    Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.

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