“Today’s volatility is normal per past periods — except for
the past two years,” said Brad McMillan, chief investment
officer of Commonwealth Financial. “We have gotten used to a
much calmer environment recently, which has created a false
expectation that the market really is calm. In fact, what we
are seeing now is much more normal than 2017 was — and we
better get used to it.”
In fact, 2017 didn’t see a drop of more than 3% for the entire
year, notes Andrew Crowell, vice chairman of D.A. Davidson.
“We went 404 days without a drop of 5%. This is highly unusu-
al,” he said, adding that for the eight years since the end of
2009, the S&P 500 increased 138% (not including dividends),
or 11.4% annually.
During that same eight-year period, the S&P 500 index
dropped by at least 5% on 14 separate occasions. “Each time,
however, the bull market remained intact, and the market ultimately went to new highs,” he explained.
Plus, since 1980, the largest annual pullback experienced in
each year has averaged - 14.9%. “Even in bull market years, it is
normal to have an 8-12% pullback within the year,” said Mike
Gibbs, director of equity portfolio and technical strategy for
Raymond James. “The recent 2018 pullback was sharp — but
within the normal range — as the S&P 500 contracted - 11.8% in
10 days from its peak to intraday low.”
Randy Rae, manager of investment strategy and research for
the wealth management firm Aspirant, agrees this year’s volatility isn’t different, although the move was “unusually swift.”
He adds that it’s “healthy for the markets.”
This “new” volatility shouldn’t surprise investors. But
given that many market fundamentals are still sound, why
did it emerge?
“It’s driven more by secondary factors than direct reces-
sion risk,” said John Lynch, executive vice president and chief
investment strategist of LPL Financial. These include a new
Federal Reserve chair, a “modestly hawkish” Fed membership
as well as those who agree with a lighter touch on regulation, a
long “unprecedented” period of extraordinarily low volatility,
and mid-term elections in the wings, he says.
Long-term periods of low volatility “eventually make the
market more sensitive to catalysts,” and mid-term election
years “tend to be more volatile,” according to Lynch. “Throw
in recent policy risks around trade as a kicker,” he explained.
Still, the Dr. Jekyll and Mr. Hyde action by the VIX certainly
should cause pause, notes Grant Jaffarian, portfolio manager
at Crabel Capital Management, LLC.
“The existence of two completely different volatility scenarios, all within about a six-week stretch, makes it hard to argue
against market volatility looking somewhat ‘different’ than it
has in the past. The ‘why’ is difficult to answer with certainty,”
Jaffarian said. Still, he believes there are several post-2008 factors that are commonly overlooked.
First, “There has been a constant and deep flow of assets
into products that end up operating in similar ways,” the
portfolio manager explained. At least four broad categories of
investments “have theoretically hastened a volatility reduction
across global markets,” he says.
Examples of strategies that could operate as “volatility
dampening” inflows include beta products that target market
returns like the S&P 500; alternative-beta vehicles that target
market inefficiencies in a rules-based fashion, such as value
equity investing; risk-parity oriented investments that aim to
frequently rebalance for several market “beta” returns like
equity risk, fixed income, etc.; and trend-following funds that
target momentum across several asset classes.
A Bumpy Start to 2018
The Volatility Index, or VIX, which measures the implied volatility of the S&P 500 index, jumped 116% on Feb. 5 while the
S&P 500 index plunged more than 4%. Volatility was picking up before the spike, and has remained active since.
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