What Is the Economic VIX? -- Journal Report
By Simon Constable
Many investors are familiar with the VIX, or volatility index,
that measures how much investors expect to see the S&P 500
But far fewer know even a little about a measure of volatility
in economic growth called the Economic VIX Index, created by Jim
Paulsen, chief investment strategist at investment-management and
research firm Leuthold Group. The Economic VIX is important now
because its history over the decades since World War II shows that
stocks do best when economic volatility in the U.S. is at its
lowest or its highest -- and the pandemic is stoking economic
volatility that Mr. Paulsen believes will be historic.
"Over the next four quarters we'll have a level of economic
volatility never before seen in the postwar period," Mr. Paulsen
says. "It will blow away the volatility" of the 2007-09 recession,
when the Economic VIX shot up to its previous postwar peak.
Growth in U.S. gross domestic product is expected to hit an
annualized rate of 15.2% in the current calendar quarter, then drop
to 6.8% in the fourth quarter and 5.8% in first quarter of next
year, according to the results of the Wall Street Journal Economic
Forecasting Survey -- the kind of big swing that pushes the
Economic VIX higher.
Here's what that could mean for stocks: From 1950 to 2020, when
the Economic VIX was within its highest quartile for that period,
the S&P 500 averaged annualized total returns of 21.2% over the
next quarter, Leuthold's analysis shows. When the Economic VIX was
within its lowest quartile, returns averaged an annualized 16.6%
over the next three months. When the Economic VIX was within its
two middle quartiles, annualized returns for the following quarter
Over those seven decades, the Economic VIX ranged from roughly
0.2 to 3.4. (The index represents the standard deviation of
quarterly annualized percentage changes in U.S. nominal GDP over
the previous three years divided by the average annualized
quarterly growth rate over those three years.) Mr. Paulsen expects
the index to reach 13 in the coming months. Given the historical
performance of stocks during periods of high economic volatility,
that should make this a good time to invest in stocks, he says.
But why do stocks perform so well when economic growth is highly
volatile? "High Economic VIX signifies that the economy is in an
unsustainable situation and everyone is working to improve it," Mr.
Paulsen says. The government typically rolls out emergency measures
to help stabilize the economy, as both Congress and the Fed have
during the current crisis. "Policy officials are scared to death,
and they are bringing every conceivable tool they have to get us
out of the situation, " Mr. Paulsen says. Meanwhile, companies cut
costs and improve their finances. Those government and corporate
efforts are "a powerful combination for growth," he says, and that
tends to be good for stocks.
Another factor, Mr. Paulsen says, is that investors tend to pull
money out of stocks as the economy begins to waver, as they did in
the bear market we saw earlier this year. But eventually that
accumulation of cash in investor hands builds to a point where it
becomes powerful fuel for a potential market rebound, like the one
we've seen over the past few months.
Mr. Constable is a writer in Edinburgh, Scotland. He can be
reached at email@example.com.
(END) Dow Jones Newswires
August 08, 2020 09:14 ET (13:14 GMT)
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