Even though the VIX has returned to February levels and the S&P 500 has rebounded, prices of VIX futures are implying volatility could stay ~50% above normal through year end. Higher risk means higher return expectations are warranted, or a need to lower equity risk exposure. Joanne Hill discusses implications and strategies to navigate this higher risk environment for the remainder of 2020.
“It’s a new investment world in 2018. Out of the gate, in January we saw equity indexes rising at an unprecedented pace only to be followed by very rough seas, where equities were lifted and then pushed down in rapid succession. This year has brought a stark and clear change in risk along with a more muddled outlook for the direction of both equity and bond markets.”
“S&P 500 Return Relative to Risk: 2017 in the Context of the Last Three Decades”
“Much attention has been given to the low level of S&P 500 volatility in 2017, with its annualized standard deviation of 6.7%, the lowest level since 1964. But what also stands out is that this low-risk environment has been accompanied by strong S&P 500 returns—21.8% in 2017.”
“The equity markets have recently been tranquil and very friendly to investors, reaching new highs and registering low volatility. The length of time since a significant decline in the S&P 500 has been unusually long. Just like an extended period of good weather changes our behavior and outlook, the tranquil markets may be related to shifts in investor behavior. Is this a blessing or a curse? It depends on one’s point of view.”
“We’ve been here before—with the VIX (The CBOE’s Volatility Index) settling in the 10% to 12% range while realized S&P 500 volatility hovers around 6% to 8%. Have you ever seen an ocean smooth and calm like a lake, with gentle waves lapping on the shore? It happens occasionally, and how wonderful it is. We can even let toddlers put their toes in the water. But a calm ocean rarely lulls us into thinking large waves cannot come crashing in again with little or no warning. Weather can change suddenly. So can the markets.”