This Month’s Newsletter

Volatility is back, but is it the end of the world? Join our Monthly Newsletter August 2019

Mark R. Hoffman

CEO, Principal

Any investor in the US stock market has enjoyed a nice bull run over the past 10 years. Much has been made of the reasons why: highly dovish monetary policy, solid earnings growth, reversion to the mean following the 2008-09 correction, historically low volatility, etc. But these last few weeks have many investors nervous. Volatility in the US stock market is back. But does that signal the end of the world?

As I write this article, the CBOE Volatility Index⁽¹⁾ (the “VIX ”) has jumped from 14 at the beginning of August to the low 20’s. That’s a 40%+ jump in less than two weeks! Enough to make anyone worry. But just how worried should we be?

First, let’s put the current VIX reading in historic context. Here is a look at the daily VIX since the creation of the index in 1990⁽²⁾:

Since January 1, 1990, the average daily reading of the VIX has been 19.05. Is the current reading (I’m writing this on August 7 at 2:00 pm) of 20.1 higher than the average? Yup. But it has only been higher than this average for the last four days. Is it high for the year? Well, no. Most of us have forgotten that the year started out with pretty wild volatility and the VIX opened 2019 at 23.

Next, we ask the question, “Does a high VIX reading spell doom for stock market returns?” We looked at that, too. While we have given back some of the gains for the year, the S&P 500 total return (as of 8/7/19) stood at 13.9%. That’s a pretty healthy return and well above long-term averages skewed by the internet and dot-com era when the S&P returned 20%+. But that’s just one data point. What if you look at the entire sample (since 1990)? On the next page is a scatter chart of average daily VIX per year (horizontal axis) vs. the S&P 500 total return for the year (vertical axis). The red dot is where we are today in 2019.

I ask you to look at this chart and tell me whether or not there is a correlation between a high VIX level and low S&P return. If you look hard enough, you might say “yes,” but it would be a weak yes. [Truth be told, there is a very mild statistical significance of the correlation of these two.] But as we used to say in the consulting world, “A duck could not fly through this chart.”

So to sum up…Has volatility picked up? That depends on your time frame. Over the past month, yes. Since the beginning of the year, no. Versus long-term historic averages, we are very nearly on it. Does a high VIX reading mean lower stock market returns? Sometimes yes, sometimes no. But where we are right now – at this moment in time – does not tell us that everyone should panic. What everyone should do is adopt a solid, proven investment strategy and have the discipline to follow it. There will be ebbs and flows. But a knee-jerk reaction to a spike in volatility will more often hurt you than it will help you.

⁽¹⁾ Created by the Chicago Board Options Exchange (CBOE), the Volatility Index, or VIX, is a real-time market index that represents the market's expectation
of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors'
sentiments.
^₍₂₎ Source: www.macrotrends.net/2603/vix-volatility-index-historical-chart
⁽³⁾ Source: www.macrotrends.net/2526/sp-500-historical-annual-returns, www.macrotrends.net/2603/vix-volatility-index-historical-chart

Mark is a co-founder of Lanier Asset Management and serves as its Chief Executive Officer. Prior to founding Lanier, he was a partner at The Boston Consulting Group. Mark is an honors graduate of The University of North Carolina at Chapel Hill with a BA in Economics, and holds an MBA from The Harvard Business School.