Personal Finance

The indicators of market volatality

Aarati Krishnan | Updated on March 29, 2020 Published on March 29, 2020

The indicators mentioned below help you avoid pitfalls of absolute bad timing

These are nerve-wracking times for investors who bought into stocks or equity mutual funds during the past couple of years.

Being fearful when others are greedy and being greedy when others are fearful is a good maxim to follow. But how can one gauge if the dominant mood in the market is one of greed or fear? Here are three indicators you can use.

India VIX

India VIX, or the India Volatility Index, disseminated by NSE, is the fear gauge often used by informed investors.

The India VIX captures the volatility in the Nifty 50 expected by market participants over the next 30 days, using strike prices of Put and Call options on the index.

India VIX is expressed as an annualised percentage, and volatility expectations captured in it can include both upward and downward moves in the Nifty. But in the past, a sharp spike in India VIX has usually signalled rising fear in the stock market.

Going by history, the India VIX has usually hovered at 15-20 when markets go about business as usual. In bull markets, when complacency is high, it has been known to dip to 10. But full-blown panic phases have seen it soar above 80. Last week, on March 24, the India VIX soared to 86.6.

While using the India VIX to gauge the fear factor, there are two things to keep in mind.

One, this index does not provide advance warning of a bear phase. For instance, at the beginning of March, India VIX was at a relatively placid 20. During the global financial crisis, the India VIX spiked to 80 plus only in November 2008, a good 11 months after the indices had lost 60 per cent from their January peaks.

Two, a high point in the India VIX need not signal a market bottom, as markets can retest their lows several times before bottoming out.

During the financial crisis, the market bottom in March 2009 came a full five months after the VIX peak in November 2008.

Surge in gold

When panic sets in in financial markets, investors usually seek out safe havens such as gold.

An unusual and persisting spike in global gold prices is, therefore, a good indicator of rising fear factor.

Data over the last 30 years suggests that when investors are sanguine about financial markets, global gold prices (in dollars) usually trade in a range with monthly moves of 5 per cent or less. When investors are sanguine about other financial assets, gold prices drift downwards. But when financial market turbulence is in the offing, bullion turns hyper-active.

Tracing the history of monthly price moves, monthly spikes of 10 per cent or more in global bullion have usually been a sign of coming turbulence.

Global gold prices consistently clocked one-month returns of 10-plus per cent between September and October 1999, just ahead of the dotcom bubble burst. Bullion prices consistently recorded one-month returns of 10-plus per cent in April/May 2006, September 2007, November 2007 and January 2008, before the financial crisis battered stocks.

Unlike the VIX, gold prices can provide advance warning of a coming correction in stocks. But they can sometimes raise a false alarm, too, because apart from financial market cues, gold also responds to factors such as oil prices, commodity inflation and geopolitical risks.

The final capitulation stage of a market meltdown can also see gold tumble along with every other asset.

Nevertheless, consistently high trailing returns on gold are a good indicator of brewing unrest. While trying to gauge the fear factor from gold price moves, using the dollar price is more effective than using the Indian price.

Retail MF flows

The buying behaviour of investors in equity mutual funds can tell you whether greed or fear is the dominant mood in the market. The AMFI puts out monthly data on the net inflows into different categories of mutual funds. Net equity fund inflows tend to scale new records when optimism among retail investors is high and register sharp declines when their mood is gloomy.

For instance, net equity fund inflows, which averaged about ₹2,000-3,000 crore a month between April 2007 and December 2007, reached a crescendo of over ₹12,000 crore in January 2008. As the market crash began in the right earnest in January, these flows halved in February 2008 and had dwindled to nothing by March 2009, when the bottom was finally made.

This time around, net inflows into equity funds have been on a rising trajectory until February 2020 averaging about ₹10,000 crore a month, capturing a complacent mood among investors. The yet-to-be-released March numbers, if they show a collapse, will tell us if fear has since taken over.

Retail flows into equity funds, however, are a lag indicator of greed and fear in the markets.

Published on March 29, 2020

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