One of our favourite indicators that we monitor when looking at equity market indices is the volatility of the index - there is frequently low volatility at points when investors become complacent and risk is high, as perceptions and attitudes change the bullish become the bearish with markets falling and volatility rising. Look at the graph of the FTSE-100 below in blue and the VFTSE (FTSE volatility) in red.
As you can see we are now at ultra low volatility and the FTSE 100 recovering to its previous peaks - will the rally run out of steam or will Central Banks Quantitative Easing keep volatility at bay?
Just to show how closely these two are correlated look what happens when we turn the volatility graph upside down, the last 10 years in particular have been pretty close.
Whilst it is a bit of a chicken or the egg - does declining equity markets cause the volatility or rising volatility cause the declining equity markets - its useful to consider the markets overall position and compare with other indicators to build a framework for investment decisions.
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