The Verus Team

Welcome Back Volatility!

Derek Majkowski. Any opinions are those of Derek Majkowski and not necessarily those of RJFS or Raymond James.

According to Investopedia: The VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking, is calculated from both calls and puts, and is a widely used measure of market risk, often referred to as the "investor fear gauge."

Prior to February of 2018, the Volatility Index, as measured by the VIX, had a 52-week range of 8.56 on the low end, and 17.28 (seen in August 2017) on the high end.  You have to go back to the US Presidential Election of 2016 to see the VIX above 20, and it has not been above 25 since Brexit (June of 2016). 

Often considered a fear barometer, the lower for longer VIX prices also was reflected in a steadily climbing stock market.  A stock market (measured by the Dow Jones Industrial Average (DJIA), S&P 500, and / or NASDAQ Composite) that was up over 5-7% in January. 

In the four trading days of February, we have seen the VIX move within a range of 12.5 to over 50..  That’s a huge spike in volatility, or as some may term it, fear..  Simultaneously, the above mentioned markets retraced all of their gains of January, and the DJIA and S&P 500 actually moved into negative territory on the year as of the market close of February 5th.

The last time we saw a spike in volatility above 50 was back in August of 2015.  During that month and subsequent six months following, we saw the VIX move in a much higher and wider range of 12-30.  This was much different than the more benign months ahead of August 2015.  During that time as well, stock prices were more volatile as well.  The S&P went from an all-time high above 2100 to a low print of 1810 in February 2016, before recovering.  That represents a 15% correction.

So what does this mean in February in 2018?

Well mainly, it means volatility is back.  After basically being relatively calm for almost two years with the VIX ranging from 8.6 to 26 (at a peak), we may be in a range that is now elevated for several months. If that is going to occur, then it would be reasonable to expect wider swings in stock prices, and if that occurs, it will make near term price predictability harder to pinpoint.

Many have been spoiled over the past two years while stock prices steadily climbed, and while that has been welcomed and fun to watch, it’s not realistic with risk assets.  Equities, while still attractive to us, do not go straight up, and the recent spike in volatility and subsequent drop in stock prices, has reminded us all of that fact in a hurry.

How does this volatility revival impact portfolio construction?

To begin with, we assume that we are talking about the funds that someone can afford to invest in equities.  This means that emergency funds, and any short, to intermediate term funds are in more conservative, less volatile assets and investments, and are easily available to meet one’s needs and priorities.

For those that are looking at their longer term funds, we want to briefly back up and address what you may have been doing ahead of this recent volatility.  Simply put, you were either not fully participating and held more cash waiting for a pull-back; you were invested and systematically pruned profits and raised cash; or did nothing and stayed pretty much fully invested.

In any of the above, addressing what to do next depends on whether you think this is the beginning of a choppy correction (as we currently do), or feel this is a reversal and the start of a bear market. 

Generally, if you do have access to cash because you have not been invested, or have been taking profits off the table in anticipation of a pullback.  This may be a good time to prepare a shopping list of names or sectors you would like to own. 

Opportunity is presented when we see big drops in prices, but when things hit that crescendo moment from a fear / anxiety standpoint in the short-term, it does not mean the volatility immediately and suddenly subsides.  It usually takes some time for prices and volatility to settle after a quick “shock” or big spike.  Prices can still go lower, and choppy sideways action can take some time before resuming their climb.

So we always suggest exuding patience and wading in with smaller increments vs. jumping in aggressively.  We prefer to see the VIX settle down a little and price action to tighten as compared to the big intraday swings that happen on those big volatile market days.  We like when the market environment is less exciting and becomes more subdued.  If equity prices are generally lower than where they previously peaked, and fundamentals (both macro and micro) appear intact, we think it makes sense to add to your positions.

For those that may feel overinvested in stocks when volatility spikes - like we are witnessing now, or feel this is the beginning of a reversal in market direction.  Then you may want to raise cash on any bounce.  Often when there is a surprising and relatively sizeable market drop and gap up in the VIX, there will typically be a reversal or some bounce.  This is an opportunity to raise cash to put oneself in a better overall allocation, or unwind certain positions.

As I write, the market did recover some of the losses from yesterday, and while not at the peak prices we saw several weeks ago, they are higher than the low they hit intraday, and are significantly higher still than where we were one year ago.  Those price swings will happen in volatile markets and do present opportunities to raise cash, protect profits, or reposition portfolios if you feel over-weighted in stocks. 

Regardless of where you are currently positioned in stocks, and how you feel about the market direction.  The recent storyline of steady equity markets climbing with extremely low volatility, appears to be over for the meantime.  If history is any indication, dramatic moves in volatility are typically not one or two day events, but something that may play out over the course of months. 

So despite our opinion that there are a lot of positive reasons to like stocks fundamentally (where appropriate of course), it is clear that in the near term we are going to see much more dramatic price swings and volatility than we saw in 2017.  Prepare for it..

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This information has been obtained from sources deemed to be reliable, but its accuracy and completeness cannot be guaranteed; it is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. All investing involves some degree of risk, investors may incur a profit or loss regardless of the strategy or strategies employed. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index used to measure the daily stock price movements of 30 large, publicly owned U.S. companies. The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. 2018-006579