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Prepare for the Return of Market Volatility

Markets remained calm as corporate earnings satisfied investors and controversial actions from the White House surrounding Obamacare and Iran were largely ignored by investors. The situation around the Catalonia region declaring independence remains fierce but some indications of willingness to work with the central government helped the Euro.

Weekly Returns:
S&P 500: 2,553 (+0.2%)
FTSE All-World ex-US: (+1.8%)
US 10 Year Treasury Yield: 2.27% (-0.10%)
Gold: $1,275 (-0.4%)
EUR/USD: $1.182 (+0.8%)

Major Events:

  • Monday – GE said it would give activist Trian Fund Management a seat on its board.
  • Monday – The Trump administration said it would withdraw carbon emission limits currently imposed on power plants.
  • Tuesday – GM acquired Strobe, in an effort to bolster its position in the self-driving car race.
  • Thursday – President Trump signed an executive order to end cost-sharing subsidies to insurers.
  • Thursday – AT&T said it lost 90,000 TV subscribers as more people turn to streaming.
  • Thursday – Increased credit card lending and cost-cutting allowed Citigroup and JP Morgan to grow earnings by 7.6% and 7.1% respectively.
  • Friday – President Trump said he won’t certify if Iran is complying with the 2015 nuclear accord agreement and called the country a “rogue regime”.
  • Friday – Saudi Arabia said it is considering abandoning plans for an international IPO of state-owned Saudi Aramco.

Our Takeaway:

The S&P 500 didn’t move more than 0.25% on a single day this week. The VIX, a popular measure of expected volatility closed at 9.6, the lowest level in at least 10 years except for a brief period in July and also earlier this month. This type of calm is nice – especially when there are lots more small up days than down days. It is also interesting. There are plenty of things in the world that could, and usually would cause volatility, but markets just don’t seem interested.

Some attribute the phenomenon to the rise of ETFs and passive investing. It could be that more investors are finally buying into the concept of long-term strategies but we don’t see much reason why an increase in index funds would lower overall market volatility. If anything, theoretical lower active volume on individual stocks would make them more volatile.

It is easy to say low volatility will likely pass soon. And investors should be prepared for that, but the truth is no one knows. The risk is becoming complacent and making bets that could be too risky if volatility does return. We believe those writing options, using leverage or who simply making a general asset allocation plan would be well served to model risk based on longer-term historical volatility assumptions rather than data from the last few years.

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