{"id":23633,"date":"2023-10-01T19:07:56","date_gmt":"2023-10-01T19:07:56","guid":{"rendered":"https:\/\/microloannexus.com\/investing\/volatility-knocks-heres-how-you-can-use-the-vix-to-beat-the-stock-market\/"},"modified":"2023-10-01T19:07:57","modified_gmt":"2023-10-01T19:07:57","slug":"volatility-knocks-heres-how-you-can-use-the-vix-to-beat-the-stock-market","status":"publish","type":"post","link":"https:\/\/microloannexus.com\/?p=23633","title":{"rendered":"Volatility knocks: Here\u2019s how you can use the VIX to beat the stock market"},"content":{"rendered":"
\n
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<\/p>\n

\n

\n \u201c<\/span> Pick a middle-of-the-road VIX level that corresponds to your target equity allocation. \u201d<\/span>\n <\/p>\n<\/p><\/div>\n<\/p><\/div>\n

The U.S. stock market is struggling, but you may still want to give the bulls the benefit of the doubt.<\/p>\n

That\u2019s the conclusion I draw from a landmark study into using volatility as a market-timing indicator. Entitled \u201cVolatility-Managed Portfolios,\u201d it was conducted by finance professors Alan Moreira of the University of Rochester and Tyler Muir of UCLA. The study challenged conventional wisdom\u2019s view of volatility, finding that you can beat the market over the long term by having higher equity exposure when market volatility is lower.<\/p>\n

\n

I\u2019ve written before about Moreira\u2019s and Muir\u2019s research. I\u2019m focusing on it now because the CBOE Volatility Index
\n VIX<\/p>\n

VX00,
\n +1.97%<\/bg-quote>
\n in mid-September fell to lows not seen since early 2020. It dropped so low that some financial advisers deemed it \u201cmysterious.\u201d Since then the VIX has jumped, though it remains 20% below its historical average.<\/p>\n

It seems difficult to put a bullish spin on the low the VIX established in mid-September, given that the last time it was as low was immediately before the stock market\u2019s waterfall decline \u2014 in which the S&P 500
\n SPX
\n shed 34% over 33 days. But no market-timing system is perfect. Even after taking that huge misstep into account, the professors\u2019 approach has beaten a buy-and-hold strategy over the long term.<\/p>\n

That doesn\u2019t guarantee that it will continue to work, since it\u2019s always possible that \u201cthis time is different\u201d (to quote the four words that are considered the most dangerous on Wall Street). But absent some fundamental change in the markets that render the professors\u2019 research no longer useful, their approach deserves serious consideration. They showed that you can boost your risk-adjusted performance over the long term by gradually increasing your equity exposure as the VIX falls, and vice versa.<\/p>\n

Volatility advantage<\/h2>\n

Though the volatility-based market timing strategy the professors outline in their study is perhaps more complicated than some of you would be willing to follow on your own, they have provided me with a more elementary version that would be easy to implement. <\/p>\n

The core idea is to pick a middle-of-the-road VIX level that corresponds to your target equity allocation. To calculate your equity exposure level in any given month, multiply your target by the ratio of your VIX baseline to the closing VIX level of the immediately preceding month.<\/p>\n

To illustrate, let\u2019s assume your target equity allocation is 60%, and the middle-of-the-road VIX level that corresponds to that target is the historical median of 17.79. Given that the VIX at the end of August was 13.57, your equity allocation for September would be 78.7% (60% times the ratio of 17.79\/13.57). And let\u2019s say the VIX finishes September at its level on Sept. 22, your allocation for September would be still above your target level, at 65.6%.<\/p>\n

The professors\u2019 approach works because, over the long term, the stock market on average performs better, relative to the volatility of its returns, when volatility is low. You can see this in the table below, which segregates all trading sessions since 1990 (when the VIX was created) into quartiles. Notice that the highest return-to-volatility ratio is for the quartile of days when the VIX was lowest.<\/p>\n\n\n\n\n\n\n
\n \u00a0<\/p>\n<\/td>\n\n Average Wilshire 5000 return over subsequent month<\/strong><\/p>\n<\/td>\n\n Standard Deviation of subsequent-month returns<\/strong><\/p>\n<\/td>\n\n Ratio of return\/volatility<\/strong><\/p>\n<\/td>\n<\/tr>\n
\n 25% of days with lowest average VIX level<\/p>\n<\/td>\n\n 0.81%<\/p>\n<\/td>\n\n 2.50%<\/p>\n<\/td>\n\n 0.33<\/p>\n<\/td>\n<\/tr>\n
\n Next 25%<\/p>\n<\/td>\n\n 0.65%<\/p>\n<\/td>\n\n 3.56%<\/p>\n<\/td>\n\n 0.18<\/p>\n<\/td>\n<\/tr>\n
\n Next 25%<\/p>\n<\/td>\n\n 0.66%<\/p>\n<\/td>\n\n 4.79%<\/p>\n<\/td>\n\n 0.14<\/p>\n<\/td>\n<\/tr>\n
\n 25% of days with highest average VIX level<\/p>\n<\/td>\n\n 1.55%<\/p>\n<\/td>\n\n 6.64%<\/p>\n<\/td>\n\n 0.23<\/p>\n<\/td>\n<\/tr>\n<\/table>\n

The table also shows that the conventional wisdom about VIX isn\u2019t wrong: The stock market\u2019s raw performance is indeed better, on average, in the wake of days in which the VIX is particularly high. But what that conventional wisdom glosses over is that those returns are particularly volatile. The standard deviation of subsequent-month returns following the top quartile of trading sessions is nearly three times greater than for the bottom quartile, even while the top quartile\u2019s average return is less than twice as much.<\/p>\n

So don\u2019t give up on the bull market just because the VIX recently hit such low levels. If the future is like the past, it\u2019s a good bet that the U.S. market will produce above-average risk-adjusted performance in coming months.<\/p>\n

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at <\/em>mark@hulbertratings.com<\/em><\/p>\n

More: <\/strong>The Fed got inflation wrong. That\u2019s why a 2024 downturn looms, says professor who pioneered popular recession predictor.<\/p>\n

Also read:<\/strong> The U.S. could be in a recession and we just don\u2019t know it yet<\/p>\n<\/p><\/div>\n<\/div>\n

Read the full article here<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

\u201c Pick a middle-of-the-road VIX level that corresponds to your target equity allocation. \u201d The U.S. stock market is struggling, but you may still want to give the bulls the benefit of the doubt. That\u2019s the conclusion I draw from a landmark study into using volatility as a market-timing indicator. Entitled \u201cVolatility-Managed Portfolios,\u201d it was<\/p>\n","protected":false},"author":1,"featured_media":23634,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[49],"tags":[],"class_list":{"0":"post-23633","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-investing"},"yoast_head":"\nVolatility knocks: Here\u2019s how you can use the VIX to beat the stock market | Micro Loan Nexus<\/title>\n<meta name=\"description\" content=\"\u201c Pick a middle-of-the-road VIX level that corresponds to your target equity allocation. \u201d The U.S. stock market is struggling, but you may still want to\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/microloannexus.com\/?p=23633\" \/>\n<meta property=\"og:locale\" content=\"en_US\" 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