Another Interesting Fear Index to Consider

by Wayne Ferbert on April 3rd, 2012

As you know from our book, fear is a primary driver in the markets. On Sunday, the Wall Street Journal online had a very interesting new chart that looks to graph the amount of fear in the market. The article is here – and the graph with the index is below.

As we pointed out in our book, when fear grips a market and becomes the primary driver, all assets become highly correlated as they all begin to free-fall. Advisors always tell you to diversify your stock portfolio by adding in fixed income, commodities, and alternative assets because they have a low historical correlation to stocks.

But remember the free-fall in 2008 and early 2009? Most of these assets all fell in unison – pointing out that fear just drives the decision to sell and get defensive. The emotion drives the decision – not the analysis.

The chart in the WSJ article outlines a fear index that you don’t often see. It shows the correlation between the US Dollar and these ‘other assets’ that usually are used to diversify a stock portfolio. The other assets, specifically, were Investment Grade bonds, gold, oil, the S&P 500 Index, and the CBOE VIX.

According to the source for the chart (Macro Risk Advisors), the correlation between the dollar and these assets is typically close to zero – but at times of stress in the markets, the correlation goes up. This makes sense for the reasons outlined earlier – fear in the market drives selling and defensive postures which drive prices in these other assets.

Here is the chart and a link to it on the WSJ site.
Source: WSJ

Notice that the fear index spiked in the summer and fall of 2011 – as the market uncertainty really increased. But the recent bull market run since late 2011 has brought the fear index back down. It is exactly as you’d expect given the market tone and the buyers that have flocked back to the market.

Over time, of course, we know that when fear gets too low, the rubber band snaps back the other direction. This is probably an index worth tracking more regularly. We’ll endeavor to show it more often! Thanks to the WSJ for introducing it to us – along with Macro Risk Advisors.

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