Market Musings 110425: Market Timing with VIX

Market Musings 110425:
Market Timing with VIX

Video: Macroeconomic and geopolitical outlook
(click underlined text to see video)

The financial markets have recently undergone a significant shift in their outlook for the United States and the rest of the world following the election of Donald Trump in November. This article delves into the underlying reasons for this change, the potential impacts on the global economy, and the strategies that Europe and other economies might adopt in response to these challenges.

Report: US tariffs – a first de-escalation
(click underlined text to read report)

US President de-escalates tariffs: On 9 April, Donald Trump ordered that the higher ‘reciprocal’ tariffs would be paused for 90 days, and a 10% minimum blanket tariff would be applied instead. There is an exception for China that now has an even higher 125% tariff, while Canada and Mexico still face 25% tariffs on goods that are not covered by the existing USMCA. The 25% tariffs on autos, steel, and aluminium are also left in place.

It is key that US Treasury Secretary Scott Bessent is now intimately involved with tariff negotiations – it has been stated that Bessent will lead trade negotiations with Japan. This has served to reassure financial markets, implying that some of the most experienced members of the Trump administration are now closely involved in driving trade policy.

Another View on Market Timing Amidst Volatile Markets

First, I should apologise for not writing anything last weekend. Frankly, with the day job it was exhausting to constantly respond to questions about the economic outlook and conclusions for financial market investments. So I decided to take last weekend off…

In this week’s article, I want to look at a very useful market timing indicator at times when financial markets are very volatile, as has been the case since April 2 (President Trump’s so-called “Liberation Day”). For a discussion of the current state of affairs regarding US import tariffs, please read the report linked above.

Everyone is struggling to absorb the short- and long-term implications of the radical shift in US policy since January, when President Trump began his second mandate.

I believe that there are tectonic shifts in a number of longstanding trends in progress, many of which were already starting to shift even prior to January. But in the interests of brevity, I will look at short-term considerations around financial markets in this article.

Financial market volatility is fairly normal

Examining the last 18 years since 2007, we have experienced a large number of market shocks:

• 2007-09: Global Financial Crisis

• 2011-12: Eurozone sovereign crisis

• 2015: Risk of Grexit - Greece leaving the EU

• 2018: US tariff uncertainty during Trump 1.0

• 2020: COVID-19 pandemic and lockdowns

• 2022: outbreak of Ukraine conflict

• 2025: Round 2 of Trump import tariffs, much bigger than in 2018

So every 3 years or so, we have experienced a bout of financial market volatility and substantial stock market falls.

VIX volatility index has spiked sharply every 3 years or so

This volatility is the price of investing in stocks for superior long-term returns over less volatile investments such as cash and bonds.

So the first conclusion is, as always: DON’T PANIC!

This volatility will eventually subside, perhaps not in the very short term, but over the coming months we should hopefully see the current excessive economic policy uncertainty subside.

Global Economic Policy Uncertainty at a New Record

Source: policyuncertainty.com

We should also consider that the recent 15-year period from 2009 has been one of the best-ever cumulative 15 years for investing in US stocks, according to data calculated by hedge fund firm Bridgewater. Even including the current correction, the S&P 500 has gained 349% over the past 15 years, averaging 10.5% per year over that span.

S&P 500 including dividends reinvested: strong performance despite corrections

The FTSE 100 including dividends reinvested has also done well, long term

Recent stock market volatility has been extreme

One way to measure the volatility (and thus to gauge the level of fear) in financial markets is to look at the VIX volatility index, which is based on the pricing of options on S&P 500 US stock market index.

Since 2008, this VIX volatility index has averaged a reading of around 23, and spent much of the 2023-25 period under 20.

However, with Trump-inspired geopolitical uncertainty hitting a new all-time high post the April 2 "Liberation Day" tariff announcement, the VIX index has touched levels above 50 for several days, even briefly touching 60 intraday at its highest .

This is a rare event, as can be seen from the first chart. The VIX index has only spent several days above this 50 level in October 1987 (The Wall Street crash), late 2008 and early 2009 (the Global Financial Crisis) and in March 2020 (the COVID-19 pandemic).

Buying stocks when the VIX has exceeded 50 and falls is a good strategy

Note from the chart below that when the VIX has broken the 50 level in the past, this has typically proven a very good time to buy the US stock market, as subsequent returns over the following 6 and 12 months have been very positive.

S&P 500 returns have been strong once VIX exceeds 50 and then falls

This recalls a famous saying attributed to Nathan Rothschild, a London financier around 1810 who said: "Buy on the Cannons, Sell on the Trumpets".

Does this work for European and UK stocks?

This is also a pretty good market timing indicator for European and UK stocks, although with slightly less impressive results.

STOXX Europe index has typically delivered strong 12-month returns once VIX has exceeded 50

As has the FTSE 100 index…

The very elevated VIX is perhaps today's financial market equivalent of the cannons sounding. While difficult to do from a psychological standpoint given the huge uncertainty, the VIX is signalling a rare long-term buying opportunity for patient investors...

Have a good week

Edmund