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Is it just me, or is it "noisy"?
10/23/2017 1:52:26 AM
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THE ETF INVESTOR
Investment management insights from a leading Canadian expert.



By Mark Taucar  | Monday, October 02, 2017


 



There’s lots of “noise” in the culture today. Just check your newsfeed for your daily dose of scandal, upheaval, and crisis. It affects markets too. But in the money management business, the “noise” we refer to is the daily swings in asset prices that often come on the back of short-term data or news. That gets digested quickly, and buying and selling volume can spike in response. Sometimes this news carries value, other times it doesn’t – it’s just noise. So how do investors tune out the background static and listen to what’s really important?

For starters, try not to be swayed by the daily grind of following who is buying and selling, and how much. Easier said than done, I know. But over the years, I’ve seen that discipline in focusing only on those indicators that could potentially identify growing risk is the best way to block the chatter.

One of those key indicators for me The CBOE Volatility Index, or VIX, which measures the implied volatility of the underlying index, the S&P 500 Composite. Basically, VIX is a measure of what options traders feel the volatility of stocks would be in one month’s time.

The accompanying graph shows the S&P 500 and VIX from 1990 to March 31 this year. VIX is measured along the left-side y-axis and the S&P 500 along the right-side y-axis. The dates corresponding to the data are on the bottom x-axis. All told, there is over 27 years of history. This is a good enough data-set to draw at least some loose conclusions about VIX and the direction of its linked partner, the S&P 500.

The orange line is the S&P 500, the black shaded area is the VIX (above and below its long-term average of 19.60, or 19.48 if you average up until Aug. 31 this year). The VIX long-term average is illustrated as a yellow line. When traders are generally confident that volatility will be lower in a month than it is today, the daily VIX reading tends to be lower. When they feel that risk and uncertainty are building, VIX spikes higher. Looking at the chart, we can see, without running any sort of statistical analysis, that when the VIX trends higher, the S&P 500 tends to fall, and when the VIX trends lower, the S&P 500 rises.

For more of a detailed analysis of this relationship, I ran a few tests to determine what the 1-year return of an investment the S&P 500 Index would be when the daily VIX was above and then below the key long-term average demarcation line – 19.48%. The accompanying table shows the results. I caution that this isn’t an extensive test of the data, but it was enough to show the basic concepts. As can be seen, there are over 27 years of daily trading data.

The average return of the negative and positive 1-year rolling returns is almost the same, at roughly +15.4% and -15.7%, respectively.

The first test: Current VIX >= long-term VIX average

This test focused on the resulting one-year rolling performance of the underlying S&P 500 where the current daily VIX was greater than or equal to the long-term average of VIX (19.48). We used 1-year rolling returns (i.e., when a new day’s data was recorded, a day (one year ago) was dropped and a new 1-year return was calculated using the new day’s data – we did that for every trading day, which resulted in 6,717 rolling yearly returns).

Where the daily VIX was greater than or equal to the long-term average 19.48, there were almost twice as many winning years (on a rolling basis) as there were losing ones - not bad. The simple average return was 6.7%, and the standard deviation looks to be higher than the average S&P 500 long-term standard deviation. Also, the averages of both positive 1-year returns and negative 1-year returns are large. The negative average was -19.6% and the positive was 18.5%.

The second test: Current VIX < long-term VIX average

This test focused on the resulting one-year rolling performance of the underlying S&P 500 where the current daily VIX was less than the long-term average of VIX (19.48).

Again, we used 1-year rolling returns. The numbers look a lot better. We observe that 86.5% of the time, 1-year rolling returns were positive – almost six times as many winning 1-year rolling periods as losing ones. Volatility was almost 40% less than that of the first test, as was the average of negative 1-year returns. When it concerns the upside, the average positive 1-year returns were 40% less than in our first test. All told, there were around six times more positive outcomes in a year if you invested in the market when VIX was below its long-term average.

Conclusions

Essentially, what the VIX graph and table tell us is that we would rather be invested in the market during periods where the daily “noise-meter” is below its long-term average. Suffice it to say, as of the end of the third quarter, the daily VIX was 9.51 compared with the average of 19.48. To me, this indicates a relative period of calm and potential for an upward trend in markets.

If forced to draw a conclusion solely on the data provided, I would say that investing in the market today would, more often than not, result in a positive outcome in one year. Suffice it to say that as of the end of the third quarter, the daily VIX was 9.51 compared with the average of 19.48.

However, on a cautionary note, we should always seek supporting evidence to confirm any opinion, and we must look to as many other indicators as possible to help in shaping our prognostications. As we know, what goes up must come down, and with VIX, the opposite is just as true.

Mark Taucar, CFA , manages discretionary client assets through Accilent Select for Accilent Capital Management Inc. He has also built and managed discretionary referral platforms for other notable Canadian money managers. Over the course of the past 10 years, he has managed institutional, pension, high net-worth and direct-client assets. His systematic investment strategies are used today by various firms in the industry . Mark can be reached by phone at 905-715-2260 or by email at mtaucar@accilentcapital.com .

Notes and Disclaimer

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

Commissions, trailing commissions, management fees and expenses all may be associated with financial asset purchases. Please read the simplified prospectus before investing. Securities mentioned are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that any security or fund mentioned will maintain its net asset value at a constant amount or that the full amount of your investment will be returned to you. Security values change frequently and past performance may not be repeated. No guarantee of performance is made or implied. This article is for information purposes only and is not intended as personalized investment advice.

 
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