Rough guide – equity investors can make better returns after periods of elevated volatility

5th January 2012 by The Value Perspective

By Nick Kirrage.

There is no doubt markets are currently going through a heightened period of volatility but perhaps the chart below will provide you with some comfort. It looks at whether there is any relationship between volatility (as measured by the Vix index) and subsequent equity market returns.

The chart highlights that at low, average and slightly elevated levels of volatility, there is no discernible pattern between equity returns and volatility. However, at much higher volatility, when the Vix is 40% or more, a pattern has emerged. It suggests investors tend to make a much better equity-market return after periods of elevated volatility. So why would that be?

The thing about market volatility is it is not rational because it stems from the actions of human beings operating generally within two contexts – fear and greed. Many of the companies being traded on the stockmarket have existed for decades and, in some cases, a century or more so is it really likely their value could move by 20% or 30% in a day? Probably not – it is just investors acting emotionally.

So, where that is happening, if you are a bit more rational, stand away from the flashing screens and occasionally take the time to wrap a damp towel round your head, you can potentially use it as an opportunity to make money – and that has certainly proved the case over the last 14 or so years of heightened volatility.

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