It has been more than 10 years since the 2008 global financial crisis, which led to the worst recession of the global economy, in post-war history. If, at that time, there had been a gauge at that time, it may have helped investors brace themselves for its impact, or at the very least provide some inkling that the market was about to experience dramatic movement, and thereby lessen the tremendous upheaval it caused.
Some might say hindsight is 20/20, but, interestingly, by the mid-to-late 2007, the Chicago Board Options Exchange (Cboe) Volatility Index (VIX), also known as the “fear gauge” was already at highs not seen since the dotcom bubble in the early 2000s. That spike signalled the market was about to move sharply, either downward or upward.
Today, investors are again bracing for rising volatility as the trade war between the US and China intensifies.
At the frontline of this battle are China’s economy and mainland companies. In May 2019, US President Donald Trump tweeted that he was thinking of raising new tariffs on Chinese goods. And it remains to be tangible actions will eventuate after the G20 Osaka summit in late June.
In May 2019, the VIX started climbing from a trough on May 3, before reaching the highest point for the month on May 13. On the same day, the Dow Jones Industrial Average and the S&P 500 fell more than 2% in their worst day since January 3.
Meanwhile in Hong Kong, the Hang Seng China Enterprises Index (HSCEI), which tracks major Chinese companies listed in Hong Kong, was trending lower in late April. By early May, it had experienced a sharp decline. The HSCEI Volatility Index (VHSCEI), which reflects the 30-calendar-day expected volatility of the HSCEI, rose. A similar pattern was observed in January when the VHSCEI reached a high, just as the HSCEI reached a low point amid global stock market declines.
Relationship between VHSCEI and HSCEI
These movements “demonstrated that the VHSCEI reflects investor sentiment when the stock market is in turmoil,” says Daniel Wong, head of research at Hang Seng Indexes Company, which launched the VHSCEI in December 2018.
A BAROMETER FOR VOLATILITY
Globally, market volatility has returned, and increased turbulence is associated with a higher level of risk. In times of uncertainty, investors want to know where the market is heading, and volatility indexes are one way to measure the level of risk, fear, or stress when making investment decisions.
“When the VHSCEI is at relatively higher levels, this generally implies that the market is expecting relatively larger changes in the HSCEI over the next 30 days, indicating that investor sentiment is uncertain,” says Wong. “Relatively lower VHSCEI values imply that the market expects little change in the HSCEI over the next 30 days, reflecting an overall view among investors that the market will be relatively stable in the short term,” he explains.
Specifically, the HSCEI measures the share price movements of Hang Seng’s H-shares (state-owned Chinese companies incorporated on mainland China and listed in Hong Kong), Red-chips (state-owned companies incorporated outside of the mainland and listed in Hong Kong) and private Chinese enterprises.
The VHSCEI is calculated through a spectrum of prices of the two nearest-term expiration months of HSCEI options that are currently trading on the Hong Kong Exchanges and Clearing Limited.
“Modifications have been made to consider trading characteristics of options in the Hong Kong market.” says Wong.
Having a quantitative measure of volatility is a useful tool to add to investors’ toolkit for many investors who have experienced abnormal levels of turbulence impacting on their investment performance during various market cycles. While volatility may spike from time to time, a case can be made that the manner in which volatility is typically measured may be attributable to the problem of sudden and unexpected volatility in stocks.
“Having a standard quantitative measure can be a smarter approach that investors can use to help them evaluate the magnitude of risks,” says Wong, adding that the VSHCEI can be used to manage volatility exposure in portfolios through the development of investment products including futures, ETFs and ETNs to manage exposure to volatility for a range of HSCEI-linked products. More specifically, the VHSCEI could be of use to investors as a hedge against investments that use the HSCEI as a benchmark.
The VHSCEI is updated in real-time at 15-second intervals.
More information about the HSCEI Volatility Index is available here.
Investments involve risks. Information provided herein is for information and reference only and does not constitute nor is it intended to be construed as any professional advice, offer or solicitation to deal in any of investments mentioned herein. The past performance is not indicative of future performance.