Nothing bearish about market calm
Market volatility continues to decline, recently hitting a seven-year low, and bears see this as indicative of 2007-type complacency, the proverbial calm before the storm. However, the decline in fear is not a warning signal – if anything, it augurs well for continued gains.
The Vix, or fear index, fell to 11 last week, way below its historical average of 20, and a reading seen just 4 per cent of the time over the last 24 years.
This might suggest little risk is priced into markets, although the Vix’s contrarian appeal can be overstated. Readings between 10 and 15, Citigroup noted recently, have historically been followed with average 12-month returns of 11.1 per cent, markets rising 88 per cent of the time.
Extremely high Vix readings during market panics tend to be brief affairs, but low readings can last for years, as happened between 1992 and 1996 and from 2004 to 2007.
Bill Luby of the Vix and More blog says history indicates volatility may well decline “or at least tread water” well into next year.
The Vix, he adds, has closed below 13 almost 1,000 times, “and almost all of these instances have been in the middle of a bull market”. Volatility drought may persist Vix readings only go back as far as 1990, but market movements over the decades confirm that volatility moves in cycles.
For example, some point out it’s been over 600 trading days since the S&P 500 moved 3 per cent or more in a single day.
Such moves have occurred on 200 occasions since 1950, or roughly once every 81 days. Therefore, the current calm is a historical freak – right?
Well, no. Back in the 1960s, investors almost forgot what such moves looked like, the S&P 500 going more than 1,600 trading days without seeing a one-day 3 per cent swing.
In the 1970s, 951 trading days passed without such a move; in the 1980s, 908 days; in the 1990s, 1,088 days; and in the noughties, between 2004 and 2007, 973 days.
It’s easy to point to apparent similarities between now and 2007, prior to the eruption of financial panic.
However, the same arguments were being made last year, just as they were in 2005 and 2006. Volatility will eventually return; in truth, however, no one really knows when.
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