By Brian Sottak, CFA®, CAIA®
Research Analyst and Alternatives Specialist
A strong start to the Q2 earnings season has boosted U.S. stocks over the past two weeks, driving the S&P 500 to record highs, and sending the VIX market volatility index down to a 23-year low.
The VIX, which is the most widely followed barometer of expected near-term U.S. stock market volatility, has now closed below 10 for more than 10 days in a row. Prior to 2017, the VIX had closed under 10 only four times from 2003 to 2016!
The VIX is derived from the price of S&P 500 Index options. The surging stock market has tempered demand for options that provide protection against price declines. Typically a low VIX reading indicates a bullish outlook for stocks, while a high VIX reading indicates a bearish outlook. The historical average for the VIX is around 20. As you can see, we have been trending well below that number over the past few years, with 2017 averaging closer to a reading of 10 on the index:
The steady upward trend of the global equity markets – and the lack of pull-backs year-to-date – has the VIX index trading at all-time lows. Seemingly complacent investors are expecting the equity markets to continue to stay calm, and to continue to grind higher. The S&P 500 has gained 10% year-to-date and its worst peak-to-trough drop has been only 2.8%. Should 2017 continue to play out this way, it would be second smallest yearly pull-back in the S&P 500 over the past 60 years. Additionally, the MSCI EAFE international equity market index and the MSCI Emerging Markets equity index also have not seen a pullback of more than 3% from peak-to-trough for all of 2017. Looking back over the last 27 years, this is a rare occurrence:
The calmness in our current markets can be attributed to many factors, from strong corporate earnings, especially across the large tech growth stocks, to the generally upbeat macroeconomic environment, and to the current lack of large risky global events. Other popular explanations to the calmness in the markets are the rise of quantitative trading and the flood of money into inexpensive passive indexing strategies such as exchange-traded funds (ETFs), which make up roughly 6% of the U.S. stock market.
History suggests that this unprecedented lack of volatility will not last forever. Stocks go up, stocks go down; they always have, and they always will. Stretched equity valuations, increasing political and geopolitical uncertainty, an increasing interest rate environment, and the Fed’s clear path toward tightening, all could be catalysts for potential increases in volatility.
Conclusion: At Mission Wealth, the key takeaways from all of the headlines and noise in the marketplace surrounding this eerie calmness are the following:
- continue thinking long-term,
- continue to remain diversified across asset classes,
- and continue to remain invested.
The steady increase in the markets over the past 8½ years has not been shared by all; many investors in recent years have missed out on the sharp rally because they were waiting for cheaper opportunities to get back in the market.
We believe our client portfolios are well positioned to navigate the upcoming time period by following a strategic, long-term approach to investing, building globally diversified portfolios that are well exposed to benefit from continued accelerating domestic, international, and emerging markets. We also maintain a dedicated allocation to less correlated asset classes, such as alternative strategies, which may perform well should we see a reversion to more normal levels of volatility and/or a market pull-back.
Your Client Advisors, and the entire team here at Mission Wealth, are here for you around the clock to help you navigate the markets, working together toward achieving your future life goals.