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Nerves and the calendar

Created:
11 November 2008
Written by:
Chris Dillow

It's well known that equity returns have a seasonal pattern. What's not so well known is that there's also a seasonal pattern in investors' appetite for risk.

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Our chart shows the average level of the VIX index - often described as a "fear gauge" - for each month since January 1990. There's a clear pattern here. The VIX tends to bottom out in June, peak in October, and fall thereafter.

Of course, you'd expect some variation from month to month simply by accident. But in some cases, the variation is just too big for this to be likely. There's a less than 1 per cent chance of the VIX being so far below average in May, June and July by chance alone, and a less than 1 per cent chance of it being so far above average in September and October. This was true even before the VIX hit extraordinary highs this autumn.

It seems, then, that investors, on average, are relaxed in early summer but get nervous in autumn. Which is consistent with the idea, proposed by Mark Kamstra of York University in Toronto, that investors suffer a form of winter blues; darker nights make them anxious and depressed, while lighter nights raise their spirits.

Of course, most fluctuations in the VIX happen because the market becomes genuinely more or less risky, and not just because of the time of year. But the time of year does matter.

And this affects asset prices. Since 1990, there has been a strong correlation (0.64 in weekly data) between the level of the VIX index and credit spreads, as measured by the gap between the yield on Lehmans' index of high-yield corporate bonds and the yield on 10-year Treasuries. This relationship suggests that the average fall in the VIX from October to May would narrow the credit spread by around 1.2 percentage points.

There's also a strong correlation between changes in the VIX and changes in the S&P 500; minus 0.75 for five-week changes in the two since 1990. This suggests the average October-May fall in the VIX would add 3.9 per cent to the S&P.

These changes are small in the context of the volatility we've had recently. But they suffice to show that seasonality matters. And we're at that time of year when this starts to turn favourable for shares and corporate bonds.

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