Wilderness bears aren’t the only ones who have gone into winter hibernation.
After a brief 97% surge from September 15 to October 15, stock market volatility has fallen asleep. Since mid-Oct, the S&P 500 Volatility Index (VIX) has cratered almost 50%. Now what?
Based upon historical correlations, the VIX and S&P 500 have moved in opposite directions 80% of the time. That means if stocks are climbing, there’s a probable chance volatility is falling. And that’s certainly been the recent case.
For example, ETPs that are linked to the performance of short-term VIX futures contracts like the VelocityShares VIX Short-Term ETN (VIIX) and ProShares Short-term VIX Futures ETF (VIXY) have slid around 28% in value over the past month while the SPDR S&P 500 ETF (SPY) has risen roughly 6.5%.
Going back one-year, SPY has gained around 17% while VIXY has been crushed 38%.
Does this kind of poor performance completely rule out investing in volatility as an asset class?
Jeff Kilburg CEO of KKM Financial an alternative asset management firm specializing in liquid alternative investments sums it up this way: “Volatility exposure in an investment portfolio is similar to an insurance policy – it costs money and you hope you never need it, but if you do, the payout will help you pick up the pieces after an unexpected event. The critical component now left to advisors is to appropriately select the most cost-efficient “insurance policy” offering maximum coverage.”
“This new approach to portfolio protection differs vastly from the Modern Portfolio Theory approach of simply having bonds offset stocks during times of distress,” he adds, “but it nevertheless enables investors to protect their portfolios in down markets without hindering them during low-volatility environments.
Barring an exceptionally unexpected event that shocks financial markets, a year-end surge in volatility doesn’t look likely.
The November to January three-month cycle over the past 63 years has been the strongest performing period for the S&P 500. U.S. stocks have gained between 1.2% to 1.7% and the current trajectory appears to be repeating itself. Put another way, the seasonal trend of higher stock prices is not a good time to be betting on higher volatility.
Nevertheless, volatility is an unpredictable beast. And although stock market volatility looks calm right now, the VIX has jumped by 15% or more on 8 separate occasions this year. No doubt, there will be a ninth time. In other words, the VIX like a hibernating bear might be fast asleep but it’s never quite dead.
Ron DeLegge is a founder and chief portfolio strategist at ETFguide. His next free Portfolio Workshop for financial advisors is on Tuesday, Dec. 12, at 1 p.m. ET.