We have been seeing a lot of volatility in global stock indexes in the past year or two. This has been in response to the looming COVID-19 pandemic crisis as well as the ongoing global trade war and the economic crisis in China. However, the truth is that most of these events have not driven the stock market to a complete meltdown. Instead, they have simply triggered a temporary spike in volatility that is expected to pass.
Gold as a safe haven and hedging asset
The price of gold has experienced an intense growth during the global financial crisis. Some analysts have questioned whether gold is a safe haven asset. However, the findings of this study suggest that the presence of this precious metal does reduce the risk during financial turmoil.
Gold has been a staple of finance for millennia. It has long been a favorite among investors for its malleable nature and conductive properties. In recent years, more investors are taking a closer look at gold as a hedge against inflation and stock market volatility.
There are various studies that have analyzed the relationship between gold and the stock market. Baur and McDermott (2010) analyzed 30-year samples from 1979 to 2009 and found that gold has a strong safe haven function during certain crisis periods. Their results show that, in the short run, gold has a good hedging effect against a stock market shock, while the safe haven property of the metal fades over time.
COVID-19 pandemic crisis
During the global stock indexes and COVID-19 pandemic crisis, a number of economies suffered large declines in financial markets. The largest decline was observed in oil companies.
In addition, demand for oil plummeted, which affected the economy. This crisis also disrupted labor markets in a number of countries. People lost their jobs and loved ones.
The impact of the outbreak was evident in many indices, including the US S&P 500 and Brazil’s IBOVESPA. However, the United Kingdom, Russia and India had negative returns.
In general, COVID-19 caused a significant increase in volatility. This was particularly true for the United States.
A study by Ramelli and Wagner investigated the adverse impact of the outbreak on stock returns. They concluded that the initial market reaction to the pandemic is characterized by a combination of investor pessimism and uncertainty.
Volatility since 2019
Global stock indexes have shown a rebound during the first quarter of 2020. However, there are a number of risks and uncertainties that are clouding the market’s outlook.
For instance, there is a possibility that the Chinese economy may contribute to the volatility in the years ahead. The same can be said for trade wars. In fact, JP Morgan analysts believe that markets have priced in the possibility of inflation.
There is also a possibility that global growth will contribute to the increased volatility in the years to come. According to a recent survey, 78% of investment professionals forecast that stock market volatility will increase over the next two years.
Additionally, the study found that the COVID-19 pandemic has had an unprecedented impact on the financial market. While there has been some correlation between the severity of the disease and the impact on the financial system, this is the first time a viral outbreak has shattered a long period of relatively calm trading.
Futures contracts fully convey the true price action
Stock index futures are an innovation in derivative security trading. Their main function is to hedge against risk associated with changes in spot price of equities. These products have gained popularity among portfolio managers and other asset managers looking for the best returns on their short-term investments. Compared to the traditional equities, the cost of these contracts is minimal.
There are several ways to play the stock index futures game. The most basic approach is to purchase a portfolio of equities that mirror the index’s notional holdings. Depending on the particular index, the size of the notional investment may vary. In the case of the Dow Jones Industrial Average, a relatively small investment in the futures market can produce significant returns.
Comparing risk-adjusted stock portfolios with equity indexes
Risk-adjusted returns help financial investors compare investments. They are calculated by calculating the return of an investment as a percentage of the risk-free rate, based on a benchmark index. These calculations are valuable tools for judging whether an investment is worth it.
The Sharpe ratio is the most widely used measure of risk-adjusted returns. It calculates the average return of an investment over a period of time, per unit of volatility. When the ratio is negative, it means that the return is lower than the risk-free rate. However, it’s important to know that the Sharpe ratio is not necessarily a reliable measurement of risk.
Factor indexes are designed to take into account a variety of factors to help determine the performance of an investment. Multi-factor indexes have shown long-term outperformance.