Late January 2021, the VIX rose +60.4% in a matter of days, peaking at 37.2 on January 27. Yet market risks clearly indicated that, at that time, that risks were isolated to stocks which is precisely what we informed our members. If all the other major markets ignored the theatrics and short-term stock volatility is this the definition of market noise?
Investors are all too aware that risks can originate from any of the major asset classes or deteriorating business cycle activity. Nobody knows how the next crisis will emerge. Taking a widespread view can help because risks are interconnected, just like markets. That's why we constantly evaluate hundreds of risks across the stock market, bond market, credit market, foreign exchange, commodities, cross asset, inflation, liquidity, macroeconomic, property and derivatives. We remove the emotion from investing.
One shortcoming of the VIX - aka the fear gauge - is its sole focus on the options market. It is a useful guide to track options activity and investor sentiment from one segment of the market. But options, just like individual stocks, can experience significant changes in supply and demand causing them to rise and fall irrespective of real fundamental risks.
Ultimately, options provide an insight into one measure of risk. But just like any other singular measure of risk, they have an extremely inconsistent track record. This is why many investors whom lack the time and expertise to identify and evaluate investment risks are forced to take shortcuts and rely on a small number of volatile measures of risk that consistently deliver false signals. Causing investors to panic and make investment decisions based on emotions, not risks.
Using a single or small number of risks for risk management decisions is no different to using a small number of stocks in your portfolio - your results will be extremely volatile and inconsistent.
For example, the VIX Index took a significant 246 trading sessions to close below 20 for the first time following the Covid crisis - following the +60.4% rise in Jan-2021. In other words, the VIX remained elevated from Mar-2020 all the way through to Feb-2021. Comparatively, the Short-Term Market Risk Index took only 53 trading sessions to decline below 20%. Therefore hundreds of market risks were repriced across all asset classes and the business cycle well in advance of the VIX which concentrates only on volatility within the options market.
The next time the VIX rises and stock investors panic, ask yourself whether risks are being repriced across the other major asset classes. If you need help identifying fundamental investment risks, help is here. Click the follow button at the top of this page to get all our insights.