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Volatility Spikes: Warning or Opportunity?

Sharp unexpected rises in volatility can be very stressful for investors, but are they a warning sign of more trouble ahead, or an opportunity to benefit from a market rebound?  

Eponymous mutual fund company founder Sir John Templeton is said to have bought companies when they hit the “point of maximum pessimism.” And Warren Buffet, sometimes referred to as the “Oracle of Omaha,” advised, “Be fearful when others are greedy and greedy when others are fearful.” Of course, “buying when others are fearful” is easy to say when you have plentiful investing capital and long-term time horizons. But, I wondered, can this advice work for investors with shorter-term outlooks as well? 

To find out, I looked at all spikes in volatility over the 27 years since the VIX’s inception and separated them into two groups: significant (VIX closes above 30) and extreme (VIX closes above 40). Because spikes in volatility tend to last several days or weeks, but don’t always stay above the initial level, I considered a “single instance” as any spike where the VIX remained within 5 points of the initial level (in other words, 25 or higher for VIX spikes to 30, and 35 or higher for VIX spikes to 40). Once the VIX dropped more than 5 points from the initial level, I viewed any subsequent spike above the threshold as a new and unique spike.  

What happens after significant spikes in the VIX above 30?

Significant spikes can be caused by a variety of different factors, but typically, they coincide with a concurrent drop in equity prices. As you can see in the table below, for each initial closing spike in the VIX above 30, the SPX performed rather well over the course of the following calendar weekaveraging 1.3% over the 24 instances that the spike occurred (although past performance is no guarantee of future results). In 15 out of 24 significant spikes, the market went up, and the only periods in which losses exceeded 1% were in September 2001 (9/11 terrorist attacks), July 2002 (dot-com-bubble bear market), and August 2011 (U.S. government credit rating downgrade by S&P).  

Table shows initial closing spikes in the VIX above 30, the SPX performed rather well over the course of the following calendar week—averaging 1.3% over the 24 instances that the spike occurred (although past performance is no guarantee of future results)

Source: Schwab Center for Financial Research. Weekly and monthly returns are actual, not annualized.
Past performance is no guarantee of future results. 

One month following these volatility spikes, the average return for the SPX was only moderately positive. In 16 out of 23 significant spikes, the market went higher. Significant losses were incurred during the Asian currency crisis in August 1998 and the financial-crisis bear market in September 2008. But, excluding these two instances, the average return increased to 2.3%. And one year following these same spikes, the SPX showed an average annual return of 6.7%. Only during bear markets, such as the dot-com bubble in 2000 and 2001, and the financial crisis in 2007 and 2008, were any losses incurred.  

What happens after extreme spikes in the VIX above 40?

While far less common, extreme spikes in the VIX can also be caused by a variety of different factors. But they, too, tend to occur along with a sharp drop in equity prices. As you can see in the table below, one week following the first extreme spike in the VIX, the average SPX return was 1.8% over the nine occurrences, and the return was positive six out of nine times. As you might expect, the one notable outlier was during the financial-crisis bear market in September 2008.

Table shows one week following the first extreme spike in the VIX, the average SPX return was 1.8% over the nine occurrences, and the return was positive six out of nine times.

Source: Schwab Center for Financial Research. Weekly and monthly returns are actual, not annualized.
Past performance is no guarantee of future results.

One month following these extreme volatility spikes, the SPX had an average return of 1.0%. In six out of eight significant spikes, the market went higher, with the financial-crisis bear market in September 2008 as the largest outlier. Excluding this one instance, the average return increased to 3.4%. And one year following these extreme spikes, the SPX had an average annual return of 13.9%. Since the financial-crisis bear market ended in March 2009, a sharp rebound had already begun by September 2009. The dot-com-bubble bear market didn’t end until October 2002, so 2002 incurred a significant loss.  

The average length of the 11 bear markets since WWII have only lasted 16.2 monthsso the dot-com bubble, which lasted about 31 months, was exceptionally long. 

What’s the bottom line?

We all know that past performance is no guarantee of future results, but over the past 25 years, except when there is an exceptionally long bear market, buying “when others are fearful” has had a relatively positive outcome, especially if your time horizon was at least 12 months.

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Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk, including risk of loss.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The Cboe Volatility Index, known by its symbol VIX, is a popular measure of the stock market's expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange (Cboe).

The S&P 500 Index is a market-capitalization weighted index that consists of 500 widely traded stocks chosen for market size, liquidity, and industry group representation.

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