Asset AllocationDecember 11, 2019

Look Out, Volatility May Be Making a Comeback

Why? The era of low VIX readings has lasted longer than normal, and there’s the unending trade war.

Reported by Larry Light

Volatility, that hobgoblin of a churning market, appears to be nudging back up. Rising to 15.7 from a low, low 11.5 in late November, the CBOE Volatility Index (VIX) may well be headed into 20-plus territory.

There’s plenty to make the VIX, known as the fear gauge, ascend. While prognosticators are doubtful about a 2020 recession, the December 15 deadline for a big tariff hike is looming. Sure, that may well be postponed, yet the trade war shows no signs of permanently easing. These days, any twitch of bad news on trade causes a quick market retreat. Imagine what a total breakdown in talks would bring.

The present reading is hardly the recent high point for the VIX. In August, amid a late-summer market downdraft linked to recession fears and trade war jitters, it shot up to 24.5. The same things happened 12 months ago, during another and much steeper market rout—the index soared to 30.4. But both cases were spikes, and the VIX quickly subsided again. In fact, the current reading is around the average for the volatility measure.

The spikes are important, though, because they likely portend a turning of the volatility cycle, argued Shawn Gibson, CIO of advisory firm Liquid Strategies and a VIX expert. A volatility cycle tends to last five years, he said, and the current one has been around a lot longer, eight years. Before that was a spell of high VIX readings that the financial crisis and its fearful aftermath drove.

In other words, we’re overdue now for a turn. “The volatility increase in 2018 was an inflection point,” Gibson said. “We’re in the early innings of high volatility.”

One can argue that the 2018 spike was partly provoked by the Federal Reserve’s policy to keep raising interest rates, which would put pressure on corporate borrowing, hence on earnings and stock prices. That policy since has been reversed, but the three recent Fed rate decreases may have just postponed the coming volatility surge.

Nevertheless, Gibson doubted that higher volatility necessarily augurs that the market is going to go down. “When the market is up, it can be a much bumpier ride,” amid high volatility, he noted, adding that such a passage also means “there will be some scars.”

One thing more volatility promises is better days for hedge funds, which thrive on choppy markets. For them, serenity is not a money maker, as so many of their blah returns in recent times have shown.

A return to volatility, to mangle that ancient Chinese curse, will make us live in interesting times.