Not only has volatility left the building, it appears to have climbed on to a hammock to take a summer’s nap. Yesterday, the Chicago Board Options Exchange’s Volatility Index (the CBOE’s VIX) closed below 10 for the 10th consecutive day.
Some perspective will help put the streak, which ended today, and the current levels into context. Over the period of January 1990 (when the CBOE first had historical data) through June 2017, the VIX only closed below 10 on 16 occasions. To reiterate, over its first 27½ years, there have only been 16 days with a closing value for the VIX of less than 10. So far this month, there have already been 10 such days, bringing the cumulative total up to 26. (The VIX is a measure of the implied or expected volatility of S&P 500 options over the next 30 days. Implied volatility is the market’s estimated future volatility. In layman’s terms, the VIX tells you whether traders are paying a little or a lot to protect their portfolios against a downward drop.)
It’s not just the U.S. equity markets. Across the globe, the equity markets are pretty calm. Yes, there are some hotspots, but overall things are just peachy from the standpoint of volatility.
A state of calm also exists in the bond markets. Every bond fund category tracked in our Quarterly Low-Load Mutual Fund Update was in positive territory during the first half of this year. If traders were fearful of inflation or interest rate increases, we’d see some losses. Furthermore, spreads between high-yield (aka “junk”) bonds and investment-grade bonds continue to be near post-financial crisis lows. Low spreads are indicative of little fear about a rise in defaults, since credit spreads measure how much extra yield investors are demanding to hold riskier debt.
I’ll refrain from making any forecasts about how long the period of low volatility will last. What I will do, however, is reiterate a big point I made in May: periods of low volatility can lure you into thinking you can handle more risk than you actually can. Your tolerance for risk is not determined by how you feel during periods of calm, but rather by how you feel during periods of high volatility. The allocation to stocks, high-yield bonds and related risky investments that you can stick with during periods of plunging prices is often (far) smaller than what you can handle during more favorable market conditions. It’s much easier to be risk-seeking when prices are stable or rising than when you see your wealth vanishing into thin air. (The pain of a loss exceeds the pleasure of a gain by a margin of 2-to-1.)
On the other hand, if the low level of volatility increases your concern about a forthcoming drop in prices, consider two things. First, volatility is harder to predict than market movements, and predicting where the market is headed is extremely difficult. Second, the greater your wealth, the larger the drop you can sustain. A simple example can explain this concept: An investor has an all-equity portfolio of $100,000 and the stock market drops 10%. The portfolio will then be worth $90,000. If the portfolio’s value first rises by 5%, to $105,000, before the 10% correction occurs, the investor’s portfolio will be worth $94,500 after the 10% drop. More so, since the starting value is higher, the portfolio could fall by 14% and still be above the $90,000 mark. In other words, by trying to avoid a downturn, you’re missing out on the potential upside that could eventually allow you to both withstand a bigger drop and leave you with more wealth at the bottom of the correction than if you were to simply sit on the sidelines holding cash.
- Creating and Following a Real Financial Plan – One of the ways you can avoid being swayed by the lack (or even the return) of volatility is to have a clear sense of what your financial goals truly are.
- CBOE’s Volatility Index (VIX) – Wayne Thorp explains in greater detail what the VIX measures and how investors can use it.
- Beware of SAFE Offerings From Crowdfunded Companies – The SEC warns that these offerings are not equity stakes and are highly risky.
- Using Financial Data to Detect Dementia – Researchers are looking into the possibility of developing a system to monitor financial transactions for signs of cognitive impairment.
It’s going to be another very busy week for earnings with 136 S&P 500 companies scheduled to report. Included in this group are Dow components: Apple (AAPL) and Pfizer (PFE), who will both report on Tuesday.
The week’s first economic reports will be the July Chicago Purchasing Managers’ Index (PMI) and June pending home sales index, released on Monday. Tuesday will feature July motor vehicle sales, June personal income and spending, the July PMI manufacturing index, the July ISM manufacturing survey and June construction spending. On Wednesday, the July ADP Employment Report will be released. Thursday will feature June factory orders and the July ISM non-manufacturing survey. Ending the week will be July jobs data—including the unemployment rate and the change in nonfarm payrolls—and June international trade data.
The only Federal Reserve officials making public appearances will be Cleveland president Loretta Mester and San Francisco president John Williams, who will both speak on Wednesday.
- Solving the Problem of Retirement
- Allocating to Manage Risk: A Case Study
- For Long-Term Investors, the Focus Should Be on Risk
The percentage of individual investors describing their short-term outlook for stocks as “bearish” is at its lowest level in eight months. The latest AAII Sentiment Survey also shows neutral sentiment rebounding back above 40% and optimism declining.
Bullish sentiment, expectations that stock prices will rise over the next six months, pulled back by 1.0 percentage points to 34.5%. Optimism remains below its historical average of 38.5% for the 22nd consecutive week and the 27th time out of the last 28 weeks.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 2.5 percentage points to 41.2%. This is the fourth time in five weeks with an unusually high neutral sentiment reading (above 40%). It is also the 13th consecutive week and the 18th out of the last 19 weeks with a neutral sentiment reading above the historical average of 31.0%.
Bearish sentiment, expectations that stock prices will fall over the next six months, declined 1.5 percentage points to 24.3%. Pessimism was last lower on November 23, 2016 (22.1%). Nonetheless, bearish sentiment remains within its typical historical range. Pessimism does, however, remain below its historical average of 30.5% for the 11th time out of the last 13 weeks.
The eight-month low in pessimism should not be construed as implying individual investors are brushing aside the possibility of a market drop occurring within the next six months. Many do view it as a possibility, as we discussed on our blog earlier this week. At the same time, the upward momentum seen in large- and small-cap stocks is providing a reason to expect stocks to rise. In between are several other factors at play, including the Trump administration’s ability (or lack thereof) to move forward on economic and tax policy, valuations, earnings and interest rates/monetary policy.
This week’s special question asked AAII members for their opinion about the current pace of economic growth. There was not a consensus of opinion. Slightly more than four out of 10 respondents (41%) described growth as being too slow, sluggish or otherwise moving at a slower pace than they would like. Many of these respondents blamed Washington politics for having a negative effect on growth. Approximately 35% described economic growth as sustainable, reasonable or steady. About 22% said growth is accelerating or otherwise described the economy as growing. Some of these respondents said the pace of growth was surprising given the current political environment.
Here is a sampling of the responses:
- “Slow but steady, and that’s good.”
- “Too slow and it doesn’t seem like Congress can get out of its own way to make any meaningful change.”
- “It should be greater with a Republican president and Congress.”
- “Good reasonable pace.”
- “It will be reasonably sustained, neither a big fall nor big growth.”
- Bullish: 38.5%
- Neutral: 31.0%
- Bearish: 30.5%
Bullish: 34.5%, down 1.0 points
Neutral: 41.2%, up 2.5 points
Bearish: 24.3%, down 1.5 points
Local Chapter Meetings
July 20, 2017 Suggestions for Conducting a Quick Analysis of a Stock
July 13, 2017 Value Works, But You May Want to Add Additional Criteria
July 6, 2017 Two Concepts That Can Affect Your Returns
June 29, 2017 Implications of the Declining Number of Stocks