Make sure your tray tables are stowed and return your seats to the upright position
On Thursday night, the so-called Fear Index – known in the trade as the VIX index, spiked. It went to 16, up from recent lows of 9 or so.
Market volatility risks in the week ahead
Investors face the triple threat of increasing geopolitical risks, while Australian corporate earnings and jobs data are also vulnerable. This video was produced in commercial partnership between Fairfax Media and IG Markets.
The VIX is a measure of the volatility of US share prices. The higher it is, the more volatile and “fearful” traders are. Hence its monicker.
The reason? The public comments from two of the least diplomatic leaders in the world, US President Donald Trump and North Korea’s Kim Jong-un. The sabre-rattling from both men, bizarrely thoughtless though it is, woke markets from their collective slumber.
When the fear returns, investors will start to fret. Photo: AP
For all of the headlines and testosterone, though, what’s surprising isn’t that volatility – and investor fear – has increased. It’s that both were so incredibly low to begin with.
No, I’m not making a judgement of our present realpolitik there. Even in more, well, normal times, a VIX in single digits is incredibly low.
It’s pretty much the investing equivalent of complacency.
The VIX is (almost) useless
Frankly, as an investor, I have very little interest in, or time for, the VIX. It’s good for headlines, and it gives impatient traders something to either obsess over or try to trade. But neither is genuinely useful for long-term investors.
VIX is good for headlines, and it gives impatient traders something to either obsess over or try to trade. Photo: Nic Walker
I wouldn’t mind – and would probably cheer – if it suddenly went away. Like most things that pass for “data” these days, it’s far more a distraction than a help. Or even informative. God knows, I don’t care whether the VIX is 9, 19 or 29.
But it’s an ill-wind that doesn’t blow some good, and if the VIX exists, we might as well learn something from it. And the lesson is this: times of low volatility are rare. They are the exception, rather than the rule.
And here’s why that’s dangerous. Over the long term, volatility is barely an irritant. Yes, it can be stomach churning to watch your shares go from $3 to $7, then to $2 and $5 on the way to $10. A gentle upward sloping journey from $3 to $10 with no bumps would be preferable for most of us.
But what’s worse is when you forget volatility like that happens. When you’ve enjoyed relative calm seas and a slowly rising market for so long, that volatility becomes a bad dream. When, to your detriment, you are lulled into a false sense of security.
The more things change … the more uncomfortable it is
We are all creatures of our environment. I’m no biologist, but the experts will tell you that living things have evolved to live in the most extreme environments on earth. Scorching heat. Bitter cold. Gale-force winds. But take those heat-lovers to the snow and you’ll kill them. Ditto the organisms that live in the coldest climes, warmed up.
And like nature, people can get used to all sorts of things … it’s change that’ll do us the most harm, not persistent extremes.
Which is why the current market worries me. Not because I fear volatility personally, but because most investors have lost their “match fitness” for that eventuality. When volatility returns, so will the fear. When the fear returns, investors will start to fret. When they do, they’re likely to make bad decisions.
In the wake of the global financial crisis, many investors sold. Those who remained became obsessed with the “next” GFC. For years after, they saw the next crash in every slight fall; the seeds of destruction in every piece of news. They became risk-averse just at the time they should have been buying.
Now, those scars have almost faded. Complacency has replaced fear. And just when investors should be preparing themselves for the inevitable return of volatility, many have let their guard down.
Franklin D. Roosevelt told us that we have nothing to fear, but fear itself. For investors, it’s not the fear, but what that fear can make us do. When a market is always volatile, you get used to riding the waves. But when we’re sitting on a glassy sea, the first big swell can induce panic.
The solution? Face the fear now. Imagine how you’ll feel when that time comes. And resolve not to give in to it. Because this is the calm before the storm.
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Scott Phillips is the Motley Fool‘s director of research. You can follow Scott on Twitter @TMFScottP or on email at ScottTheFool@gmail.com. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).