MW The market's 'fear gauge' spiked, then slid. What that means for your stocks.
By Mark Hulbert
A VIX spike can be bullish - but comes with the volatility that can shake investors out of the market
If the VIX at the end of March is where it is now, your equity exposure level for April would be a conservative 47.6%.
The Cboe Volatility Index, or "VIX" VIX - a.k.a. Wall Street's "fear gauge" - more than doubled in just 16 trading sessions from mid-February through last week. It recently was higher than 92% of all daily readings since 1990.
Contrarians consider a high VIX to be a positive sign - especially so when the VIX spikes upward as quickly as it did recently.
Except high VIX readings are not necessarily bullish for the stock market. Stocks historically do better when volatility is low.
So you might get better stock returns and rest more easily in this case by doing the opposite of a contrarian investor. In other words, keep a higher equity allocation when the VIX is low.
Support for such a strategy comes from a study conducted by finance professors Alan Moreira of the University of Rochester and Tyler Muir of UCLA, entitled "Volatility-Managed Portfolios." Several years ago, they devised a market-timing model that takes advantage of the stock market's tendency to perform better, with less risk, when the VIX is low.
A simplified way of following their model requires just two steps:
-- Pick a target equity allocation that corresponds to a middle-of-the-road VIX level.
-- To calculate your equity exposure level in any given month, multiply your target allocation by the ratio of your VIX baseline to the closing VIX level of the preceding month.
To illustrate, assume that your target equity exposure level is 60% (with 40% in a money-market fund), and you set the middle-of-the-road VIX level to be its historical median (which is 17.61).
Now, based on the VIX level of 19.63 at the end of February, your equity exposure level for March would be a conservative 53.8% (which is 60% times the ratio of 17.61 to 19.63).
If the VIX at the end of March is where it is now, your equity exposure level for April would be even more conservative, at 47.6%.
Since the VIX was created in 1990, my simplified version of the professors' strategy significantly outperformed a buy-and-hold strategy on a risk-adjusted basis. The strategy's Sharpe Ratio (a measure of risk-adjusted performance) was 0.99, versus 0.78 for the market as a whole. It's also worth pointing out that the strategy has outperformed the market in real time since the professors completed their research and began circulating it in academic circles.
Contrarian thinking
Contrarians aren't completely wrong to believe the market can do well when the VIX is especially high. But they overlook the correspondingly high volatility at such times. As a result, the market's return-to-volatility ratio is lower when the VIX is high than when it's low.
This is illustrated in the table above, which separates all trading days since 1990 into four groups based on their VIX readings. Focus in particular on the first and last rows. While the market's average subsequent-month return following the highest 25% of VIX readings is close to double that of the lowest quartile, the standard deviation of monthly returns following that highest quartile is nearly three times greater. As a result, the return-to-volatility ratio is significantly lower for the lowest VIX readings.
What could this mean for the market now, given that the VIX is solidly in the upper 25% of its historical distribution? If the stock market can post a gain over the coming month, it's highly likely it will be a bumpy ride.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
More: S&P 500 correction shows why risk tolerance matters. These strategies can get investors back on track.
Also read: Stocks have fallen, but wait for these signals before deciding it's time to buy
-Mark Hulbert
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March 17, 2025 10:22 ET (14:22 GMT)
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