Now is as good a time as any to conjure up the historic event that occurred during the first full month of my professional career in finance. It was August 31, 1998 – still the early earnings of the dot-com boom. The S&P 500 Index lost 6.8% that day to end an abysmal month for stocks (what would equate to about a 1,700 point decline in the Dow using today’s values). Yet it was not the 6.8% decline for stocks that was unprecedented. Although rare, the stock market had seen far worse one-day declines.
The unprecedented event was that the “fear index”, officially known as the CBOE Volatility Index or “the VIX”, increased above the level of 40 for the first time ever. Without getting into all the nerdy details, the VIX objectively measures a market-implied risk level using option prices. In the summer of 1998, investors were panicking about the abrupt Russian government default and the VIX rising above 40 objectively reflected the grave fear. It was unfathomable that a developed government such as Russia with the ability to print more of its currency (rubles) could fail to repay its own debt. Long Term Capital Management, a hedge fund team consisting of Nobel laureates and some of the most successful investors ever, was losing billions of dollars. It was publicly collapsing for all to see. The fear was real and it was rampant. The stock market was in chaos.
What became evident with the passage of time was that this unprecedented event and the unsettling world events that led to it represented a buying opportunity. Wealth was again transferred from the impatient to the patient. Over the year that followed, the S&P 500 Index gained 39.8%.
In the aftermath of August 1998, the VIX eclipsed 40 on six different occasions. Following these seven occasions – August 1998 and the six times to follow – an investment in the S&P 500 Index yielded an average return over the subsequent 3 years of 37.1%. The median 3-year return after the VIX topped 40 was +50.9%.
Today – February 28, 2020 – the VIX broached the magical 40 hurdle for the eighth time on record. To be clear, 40 is an arbitrary number. We could use 36.41 as the key VIX threshold to denote unusually high levels of investor fear and the numbers from the prior paragraph would look very similar except it would smell like data-mining. 40 is a nice round number so it more easily passes the smell test. There is nothing any more magical about 40 than there is about 36.41.
This morning at 9:30am, the VIX cleared 40 for the first time since 2015 and so here we are in another panicked environment where the loudest voices are the ones promoting chaos and hysteria and recession.
We have been here before. The scenarios and soundbites were all different but, in a way, they are all the same. And in all these historical environments, fearful sellers have voluntarily paid a tax. Not an income tax. A comfort tax. Selling in the face of panic for whatever comfort the selling provided has been a tax – with the proceeds of this tax collected and amassed by those who could mute the noise, turn off the 24-7 news, maintain a level-head, and appreciate the volatility for what it was.
Just something to keep in mind.