Investing

What could short-term volatility mean for long-term investors?

Markets are
continuing to be highly volatile — and the past two weeks have seen historic
gains and losses. While I prefer to evaluate performance over longer periods,
it’s understandable that investors are especially interested in the market’s
daily fluctuations. Here’s what I’ll be watching in the coming week and months.

This current market volatility could lead to tomorrow’s long-term opportunities

On Feb. 28, the CBOE Volatility Index® (VIX®) — which measures expectations of near-term volatility — closed at 40.11.1 This is unusual, as there have only been seven periods since 1990 that saw the VIX finish the week over 35, but it’s hardly surprising given the recent volatility we’ve seen.

Interestingly,
though, history shows that a weekly close in the VIX above 35 is correlated
with higher stock prices in the next year. One year after each of the
seven periods where the VIX closed over 35, the S&P 500 Equal Weight Index
was higher, with an average return of 15.5%.1 In contrast, the
average VIX  return was -38.4%. What’s
more, over the same period, the S&P 500 Equal Weight Index outpaced the
S&P 500 by 0.4%. (The one exception was the aftermath of Sep. 11 and
headwind created by the “popping” of the technology bubble.)

So, what
does this mean for investors? In my view, the VIX reflects investors’ current
state of unease, but it also represents a buying opportunity for investors
willing to take a longer-term approach.

Equity volatility may linger

The US market is in for a volatile year. Recent news reports suggest the worst of the coronavirus has yet to impact the US, and the market will be vulnerable to pricing the policy risk in the leadup to the November presidential election. The country is very polarized, so I believe there is a risk that President Donald Trump’s generally friendly fiscal/regulatory policies could be reversed. I believe the political dynamic is a reason for investors to consider holding onto low-volatility stocks. 

Tracking the impact of the coronavirus

When it comes to monitoring the impact of the coronavirus on economic activity, I recommend watching the price of oil and the direction of industrial commodity prices. Energy is critical to transportation and production, and it is likely to produce less noise than government comments and the talking heads in the media. 

Moreover, the Atlanta Federal Reserve’s (Fed) GDPNOW forecast for Q1
growth is 2.7%2, durable good orders looked to be on the upswing (helped
by the inventory cycle), and pending home sales appeared to be especially
strong. 3 Moreover, the Philadelphia Fed non-manufacturing survey
was stout, pointing to robust growth.4 The strength of economic
growth going into to the shock of the coronavirus may reduce the severity of
its impact on the market. 

1 Source: Bloomberg, L.P. as of Feb. 28, 2020. VIX closed at 45.1; on
June 4, 2010, the VIX closed at 35.5; and on Aug. 12, 2011, the VIX closed at
36.4. The seven periods where the VIX closed over 35 were Oct 31,  1997 to Oct. 31, 1998; Aug. 28, 1998 to Aug.
28, 1999; Sep. 21, 2001 to Sept. 21, 2002; July 19, 2002 to July 19, 2003; Oct.
3, 2008 to Oct. 3, 2009; June 4,  2010 to
June 4, 2011; and Aug. 12, 2011 to Aug. 12, 2012. Past performance does not
guarantee future results. An investment cannot be made into an index.

2 Source: Federal Reserve Bank of Atlanta GDPNOW as of March
2, 2020

3 Source: Bloomberg LP as of February 29, 2020

4 Source: Federal Reserve
Bank of Philadelphia Nonmanufacturing
Business Outlook Survey (NBOS) as of Feb. 25, 2020

Important information

Blog header image: Mima Foto/Stocksy

All investing involves
risk, including the risk of loss.

There is no guarantee that low-volatility stocks will
provide low volatility.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.

The S&P 500® Equal Weight Index is the equally weighted version of
the S&P 500® Index.

The S&P 500® Index is an unmanaged
index considered representative of the US stock market.

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