Is Volatility Here to Stay?

No portfolio has been immune to market volatility in 2018.  A common industry measurement of stock market volatility is The Chicago Board of Options Exchange (CBOE) Volatility Index, aka “VIX”.  The VIX tracks the expected 30-day volatility using S&P 500 options. A lower VIX number (10) suggests lower expected short-term volatility, whereas a higher number (22) implies turbulent markets ahead. It also captures investor sentiment, which is why it is often referred to as the “fear index.”

Why is volatility higher?

As equity markets climbed to new highs last year, investors became complacent with the lack of volatility. As seen in the chart below, the VIX remained subdued throughout 2017, trading well below its long-term average of 20. Investors were very optimistic about markets with the VIX closing at its all-time low of 9.14 on November 3, 2017. Meanwhile, the S&P 500 continued to grow, posting 60 new record highs with only four days of trading in which the index moved up or down by more than 1%.

Jump to 2018, on February 5th the VIX surged 116% to 37; the largest one day move recorded since inception of the index. Concerns raised over rising inflation – due to strong wage growth – which sent markets tumbling.  By February 9^th, the Dow Jones Industrial Average (DJIA) and S&P 500 entered correction territory with declines of over 12% peak to trough. Markets recovered over the next few days and as February concluded, the VIX retreated closer to its long-term average.  With tariffs threatening headlines recently, the VIX has continued on its roller-coaster ride.

Investors who were hurt the most during these choppy markets were those betting on continued low volatility. For example, two funds designed to move in the opposite direction of the VIX and allow for speculative trading on low, short-term volatility either went into liquidation, or were halved in response to the losses.

What are we expecting in the future?

We believe that global economic indicators are largely positive and corporate earnings remain strong, both of which bode well for equity markets. Additionally, in his first Congressional testimony, the new Federal Reserve Chairman, Jerome Powell, indicated a continuation of the plan to raise interest rates gradually while balancing the inflation target of 2% and avoiding an overheating economy. Moreover, global monetary policy remains generally accommodative.

All of these signals suggest there is room for continued positive returns for equity markets during 2018.

What should we do about it?

We continue to believe that investors with long-term investment horizons should not abandon their allocation strategies at this time. While recent increases in short-term volatility cannot be denied, the long-term risk profile of equities has hardly changed, and it is important to distinguish between the two. It is critical to stay focused on one’s long-term objectives during periods of short-term turbulence.