Where Has All The Volatility Gone?
August 14, 2018
By Michael List • Portfolio Manager
With 90 percent of companies reporting quarterly earnings so far this season, the average company has grown earnings per share by 25 percent from last year. Since analysts had been expecting strong earning growth again this quarter, the price reaction for each stock has been responding more to "future guidance" rather than "earnings beats" or "misses." This was clearly visible when stock like Facebook, Whirlpool, Twitter, and Newell Brands declined 10-20 percent after their earnings announcements.
Yet, even with these major declines in individual stocks, the market as a whole has still become less volatile as seen in the chart below from Wall Street Journal. The Chicago Board Options Exchange Volatility Index, better known as the "VIX," has fallen back to the low levels experienced in 2017.
What does a low Volatility Index (VIX) mean For the market?
A low VIX value means market participants do not anticipate much market volatility or fluctuation in the next 30 days. The current low VIX figures are a bit unusual for a couple of reasons. Historically, August, September and October are the most volatile months for the market. Secondly, two unresolved issues (trade tariffs and mid-term elections) add uncertainly to both rate of economic growth and fiscal policy in the future. We might be skeptical the U.S. is headed for a trade war, but the market appears certain the U.S. will not enter a trade war.
This difference brings up another interesting point from the chart. What if we (or the market) are wrong? This question is always in the back of our minds, as we build and review portfolios. In February the VIX spiked, tripling in just a couple days’ time and causing disaster for several inverse VIX funds. Unfortunately, anticipating events like this remains nearly impossible.
Our best tools to build portfolios remain diversification and fundamental analysis. Diversification helps spread the risk and limits the effects (negative or positive) of one sector or asset. Fundamental analysis is also essential; we want to own good companies at a good price. Most companies can succeed when the economy is growing by 4%. However, quality companies can prosper, regardless of whether the economy is expanding or in a recession. Another key fundamental is price. The single most important factor determining future return is the price of the asset when you buy — also known as "valuation."
If you would like to hear more about how your portfolio is structured to mitigate volatility in various market cycles, schedule a meeting with an Advisor today.