Stock markets can be plagued by volatility, but history suggests investors should stick to long-term bets

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By Mahavir Kaswa

Financial markets around the world have had a rocky start to 2022. Stock indices are falling from all-time highs and bond yields continue their upward trend. Central banks have begun raising rates and tightening the supply of “easy money” to combat the woes of runaway inflation. The Russian-Ukrainian conflict and lockdowns in major cities in China continue to disrupt the supply chain and have only added fuel to the fire. Indian stock markets have also seen heightened volatility, which has left investors uneasy after a formidable bull run over the past two years.

VIX – the “fear gauge” of the market

The India VIX – popularly known as the “fear gauge” of the Indian stock market – is a measure of expected market volatility in the near future. A high level of VIX indicates more uncertainty (or fear) in the market while a low level of VIX indicates less uncertainty. It crossed the 30 level on February 24, 2022 for the first time in almost 2 years, signaling that investors were the most “fearful” since the Covid-19 pandemic. The Indian VIX has since averaged 22.4, remaining well above its long-term median value of 18.3.

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Exhibit 1 – India VIX breaks through the 30 level after almost 2 years

Historical data dating back to 2008 suggests that markets become increasingly turbulent whenever the VIX rises above 30 (~87e percentile). At first glance, it may seem rational to be afraid in such situations. However, data shows that stock markets tend to rebound quickly after periods of heightened volatility.

Stock markets rebound quickly

To better understand this, we looked at the performance of the Nifty 500 TRI over the following 12 months when the Indian VIX was above the 30 level. There have been 468 such trading days over the past 14 years. and in 428 of those occasions (91%) the Nifty 500 TRI generated positive returns over the following 12 months. This tells us that while the stock market can be plagued by uncertainty during turbulent times like this, it tends to bounce back quickly. The scatter plot below provides a visual representation of this information where we can clearly see that the vast majority of 12-month forward returns are above 0%.

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To get a clearer picture, we compared the 6-month and 12-month forward yields during these highly volatile days (India VIX > 30) with the rolling yields across all available history.

Exhibit 3 – 6-month and 12-month forward yields when the Indian VIX breaks above the 30 level against full history

Looking at the median values, which remove the impact of outliers, we can see that the Nifty 500 TRI has historically provided returns over 3x higher over the next 6 months whenever the Indian VIX has exceeded 30. A similar inference can be drawn from the 12-month yield futures, which show returns more than 2 times higher when the VIX rises above 30.

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In conclusion, investors should not panic and give in to fear of volatile markets. History shows that stock markets tend to rebound fairly quickly after periods of heightened volatility. Therefore, investors can benefit from focusing on “finding calm in the midst of chaos” and sticking to their long-term investments in their wealth-building journey.

(Mahavir Kaswa is Head of Research, Passive Funds, Motilal Oswal AMC. Opinions expressed are those of the author. Please consult your financial advisor before investing.)

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