Market Volatility Remains at Historic Lows
The stock markets continue their record setting pace. There have been a few bumps in the road, but market volatility has remained low – for a very long time. Many are beginning to ask, can this really last?
In its simplest form, volatility is the degree to which the price of an investment fluctuates over a given period of time. Volatility is often associated with risk, as assets with a higher volatility can be susceptible to large price swings in value. With greater volatility comes greater uncertainty.
But volatility is at historic lows, and there certainly doesn’t appear to be any great anxiety imbedded in stock prices. Over the past 9 months the stock markets have been on a blistering tear. Since the November 8 Presidential election, the Dow Jones Industrial Average is up 18 percent, the S&P 500 is up 15 percent and the tech-heavy NASDAQ is up 22 percent. Despite these tremendous gains, the financial markets, and even some Federal Reserve officials, are expressing concern on the extended pace of low volatility.
Why would low volatility be of concern? Low volatility actually seems like a good thing. And how, exactly, is volatility measured?
To start, we can look to the VIX Volatility Index, which serves as the preferred gauge of measuring volatility in the stock market. Created by the Chicago Board Options Exchange, the VIX isolates and quantifies the level of volatility in the marketplace. Markets don’t like uncertainty, and as stock prices fall, volatility tends to rise. Thus, the VIX is commonly referred to as the “fear indicator”. Simply stated, it is a mathematical measure of how much the financial markets believe the S&P 500 will fluctuate over the next 12 months, with a 68 percent level of confidence. For example, a VIX value of 10 means the S&P 500 has a 68 percent chance of trading within a range 10 percent higher or lower than its current level, over the next 12 months.
On July 14, the VIX closed at 9.51, its third lowest closing price in history. The two lower closing prices, 9.48 and 9.31, occurred in December 1993. The historical average of the VIX is around 20. In the past 12 months, the VIX has had only two days where it closed above 20. For the 1st half of 2017, the average closing price for the VIX was 11.56, which is on pace to become the lowest annual daily average in recorded history. This is why the financial markets are beginning to take notice. You see, a key element of volatility is that it is mean reverting - it tends to return, over time, back to its average.
What does this data really mean? Well, analyzing the VIX requires perspective. A VIX in the lower teens simply reflects the stock markets have returned to calmer waters. On the other hand, the VIX reached the 80’s in the weeks and months that followed the collapse of Lehman Brothers in September 2008. Volatility is a fluid measure that rises and falls with the market forces that drive stock valuations. Given the consistent rise in stock prices and a moderately expanding U.S. economy, low volatility can be expected. But the financial markets, and increasingly the Fed, are beginning to wonder how long this extended lull in volatility can really last. Since March 2016, the S&P 500 has stayed within 5 percent of its all-time high, except for one day.
The VIX is not an indicator of actual volatility or what will happen in the future. It is, however, a forward-looking expectation that seeks to predict the variability of future stock market movements. And right now, the VIX’s estimate, in the short-term, is for continued calm. It’s possible the current bull market rally may push stock prices to new all-time highs, and the American economy may continue its sustainable growth in the months to follow. We’ll soon find out.
There is certainly no crystal ball to predict the future. For now, the stock markets continue to breach through historic levels with relative calm. Uncertainty has not led to panic. But there are, and there will continue to be, legitimate economic, geopolitical, monetary policy and legislative concerns confronting the markets. Markets are designed to react, and negative reactions are a reality of that fact. The Fed and the financial markets realize volatility usually returns to its average. And that’s their concern – the return to average may be a long and strenuous journey.
Mark M. Grywacheski, Investment Advisor
Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets, or developments mentioned.
Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
