Lovers of Sherlock Holmes will remember the curious incident of the dog that didn’t bark during the night.
For a while, volatility was the dog that didn’t bark, particularly in 2017 - one of the least volatile years on record. This was despite concerns about rising US interest rates, trade war threats and geopolitical worries, such as in North Korea or political uncertainty in Europe.
The dog barked loudly with the volatility spike of early February this year. The Chicago Board Options Exchange (CBOE) Volatility Index, better known as the VIX, and often used as a proxy measure of volatility across markets, closed at 38 on 5 February (with an intraday high of 50). After a few months of being elevated, it settled down again to levels just above those it enjoyed over much of last year. The local version, the SAVI (on top 40 JSE stocks), has been more elevated, but not exceptionally so (see charts below).
(The VIX was introduced in 1986 and measures the volatility implied by the price of options on the S&P 500 and is often called the “fear index” because it is a good barometer of investor sentiment. The higher the VIX, the more fearful the market is of losing money, while the lower it is, the more relaxed markets are.)
JSE Top 40 volatility index
As we discussed earlier this year ("Fighting the fear - the return of market volatility", June 2018), 2017 was one of the least volatile years on record, with the VIX hitting an all-time low of 9.14 in November, and dropping below 10 on 52 occasions during the year. It then fell below 10 five times before its February spike. Over the course of July and August, it has swung between 11 and 16, still pretty low levels considering the rhetoric between China and the US over trade.
Other measures of volatility are also showing an absence of fear. Implied Treasury volatility has also been at well-behaved levels while the US dollar has largely stuck within a 93.5 and 96.5 range over the last three months, even during August’s trade confrontations and the sell-off in the Turkish lira, rand and other emerging market currencies.
What could have calmed the watchdog? Was he barking at shadows in February or is there a villain lurking in the shadows? There have been signs of contentment in US markets, though this appears to be changing. Late in August, the S&P 500 set a new record for the length of a bull market (3,453 days as at 22 August – a bull market is commonly defined as a period without a fall of 20% or more), while the US market continued to set new record highs, pressing on from previous record highs set in February.
According to an article in Business Live / Reuters, (“Dangerously low volatility is looking like the calm before a major storm”, 8 August 2018), speculators’ short VIX futures positions earlier this month were bigger than they were before February’s shake-out and volatility spike. Bond and US dollar positions have also been stretched, with 10-year Treasury futures shorts at close to records in nominal terms.
What’s interesting about the US equity market has been its divergence from other indices around the world. The MSCI World Index is still well off its January highs, and this pattern is also shown by key indices like Hong Kong’s Hang Seng (a good proxy for China), Germany’s DAX and the JSE All Share Index. This divergence can to a large extent be explained by President Donald Trump’s tax cuts, which have boosted profitability for many S&P 500 firms. Given worries about global trade wars and rising US interest rates, one wonders if this can last.
Of course, low volatility is not a problem, as long as it stays low. But it’s hellishly difficult to predict when it will swing the other way. As we saw during last year’s period of low volatility, you can lose a lot of money betting on a quick change - that doesn’t mean you shouldn’t be prepared though.
And as we’ve noted before, it’s important to recognise that volatility is not the enemy of the long-term investor. Excellent returns have been enjoyed in the periods after a volatility spike (see article cited above). Volatile periods have often provided opportunities to buy quality companies and assets at attractive prices, while long periods of heightened volatility have often been associated with excellent returns.
The watchdog appears to be growling again now and in doing so, may be drawing us out of any complacency. Whatever the case, a good long-term investment plan remains the best strategy for dealing with market swings.
About the author
Patrick writes and edits content for Investec Wealth & Investment, and Corporate and Institutional Banking, including editing the Daily View, Monthly View and One Magazine - an online publication for Investec's Wealth clients. Patrick was a financial journalist for many years for publications such as Financial Mail, Finweek and Business Report. He holds a BA and a PDM (Bus.Admin.) both from Wits University.
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