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Light at the End of the Tunnel Thumbnail

Light at the End of the Tunnel

From March to August of this year, equity markets have raced back from the lows with remarkable speed, driven by the “stay at home” darlings: Amazon, Netflix, Zoom and others.  Since then, we have seen a bit of rangebound phase, where stocks have not had a clear direction.  

Recently, with the possibility of several successful COVID 19 vaccines on the horizon we have seen a shift, away from the “stay at home” trade.   Those companies who benefited tremendously through quarantine lost a bit of their lustre.  Alternatively, those that hadn’t benefited all of a sudden took a bounce, even airline stocks and cruise lines.  Optimism is a good thing but by no means does the hope of a vaccine spell the end of volatility.  We believe the travel industry may take a few years to return to normal. 

We are adjusting portfolios with this change, some sector rotation, adding industrials and consumer discretionary sectors back into portfolios.   

What do we see going forward?  

Most of us have heard the Warren Buffet phrase “Be fearful when others are greedy and be greedy when others are fearful”, but does it have any basis in fact?  Well in fact the answer is yes, most of the time. 

Market volatility can be tracked by an index called the VIX, also known as the “fear gauge”.  For those who want more detail, keep reading.  If not, cut to the chase at the bottom.  

The work below comes from Macan Nia, Senior Investment Strategist, Manulife Investment Management. 

“Based on our work we have found that when the VIX Index breaks above 30 it has historically marked an inflection point for corrections or bear-markets.  The VIX broke above 30 the last week of October, so we returned to one of our favourite indicators and took a deeper look at the VIX Index to see what further insights it offered.  The VIX Index is a real time market index that represents the market’s expectation of volatility over the next 30 days.  Since 1990, the VIX has averaged approximately 19 while a measure above 30 signifies an aversion to riskier assets, including equities.”  

The table below contrasts 6-month, 1 year and 2-year annualized returns for the S&P 500 Index since 1990 in all periods, periods when the VIX is greater than 30, and periods when the VIX is less than 30.  History would suggest that investors can improve their returns by becoming greedy and embracing risk when others are fearful and selling.  

Source: Manulife Investment Management, Bloomberg.  As of October 31, 2020, * Annualized Returns 

Cutting to the Chase

In other words, the S&P returns going forward 6 months to 2 years when the VIX is >30 are significantly higher than when the VIX is at lower values.  By no means is this a given, but it does suggest that probability is on our side. 

On the very short term, November and December tend to the most positive months for the markets.  

We are looking towards 2021 with optimism of the vaccines/therapeutics and eventual economic recovery.  

If you would like to talk about this or our investment thesis for the coming year, as always, don’t hesitate to give us a call.

Photo by Josh Hild on Unsplash