What’s The India Volatility Index Telling Us Now?

Unlike more popular metrics such as the PE (Price to Earnings Ratio) and the P/BV (Price to Book Value Ratio, the India VIX (Volatility Index) is rarely, if ever, looked at by investors. However, this unassuming number might actually offer important market cues, particularly for value investors.

First things first – what exactly is the VIX and what does it aim to “measure”? Originally coined by the CBOE (Chicago Board Options Exchange), the mark has been licensed to the NSE. Unlike other indicators, which typically measure degrees of over or under valuation, the VIX measures the broad level of “volatility expectations” for the next 30 days. The number itself is derived from the order book of NIFTY Index Options, based on the bid/ask prices of option contracts.

While the trading of VIX futures (“derivatives on volatility”) never really took off in our country, the number it does serve as an important cue for value investors. In a sense, the VIX captures, with a fairly startling degree of accuracy, the broad market sentiment. When you condense all market emotions and distil them to their purest level, you’ll find that either greed is prevalent, or fear. It’s old news that Warren Buffet has built a massive fortune by, in his own words, “buying when others are fearful, and selling when others are greedy”.

When traders expect high volatility in the calendar month ahead, their overall ‘confidence’ is high, and the VIX trades at a subdued level. When markets are panicky and volatile (for instance, during a ‘dump everything and run’ selloff), the VIX shoots up. In other words, a low VIX is indicative of high levels of greed within the trading community. Conversely, a high VIX implies that fear is the prevalent undertone.

Here’s the interesting inference for investors – the VIX appears, for the best part, to run contrary to other valuation indicators. In other words, the cool confidence that traders display when markets are on a canter may bring down the VIX by quashing fears of volatility, but it doesn’t necessarily bode well for investors who are looking to deploy idle cash into the market.

Consider a recent example. When the NIFTY suddenly dropped by nearly 10 per cent back in November 2016, the VIX shot up – making an interim high of 19.09 on 21 November 2016. In other words, traders expected maximum 30-day volatility AFTER markets had already fallen. Panic levels were high.

Today, with the markets a lot more buoyant, having gone up by more than 25 per cent since the November 2016 low, a calm confidence permeates – the VIX is down to a low level of just 11.37.

What’s severely worrisome is this – the PE ratio of the NIFTY (traditionally a fairly reliable, albeit out of fashion indicator of over or undervaluation) trades at a perilously high level of 26.24X today - just 2X lower than what it traded at during the meltdown of 2008! What this tells us is this – the broader market is now being fuelled by greed right now. Unless earnings growth kicks in and douses valuation indicators to more sustainable levels, there’s no saying when the famed ‘mean reversion’ syndrome could kick in, hurting many an uninformed retail investor.

Long term investors would do well to maintain a cautious approach towards equities right now. Even aggressive investors should aim for a balanced split between debt and equity assets, while first time investors must essentially use SIP’s, STP’s, or other ‘bit sized investment’ strategies to stagger moneys into the stock markets, instead of going in hook, line and sinker. A measured dose of rationality is called for at this time.