Market gyrations over the past year may feel extreme to some, but history suggests investors need to get used to it. Stock market volatility levels have been relatively normal by historical standards – aside from three days in August 2015 when the S&P 500® dropped over 9%.
The Chicago Board Options Exchange (CBOE) Volatility Index, or VIX, is a commonly cited indicator of market volatility. It is a mathematical measure of the market’s anticipated volatility. As the chart below demonstrates, high and low phases in a volatility cycle have typically endured for years, rather than just a few months or quarters. The return of market volatility could be described as a return to the “old normal.”
Late summer of 2015 marked the end of an extended period of low volatility. For the three years prior, the Chicago Board Options Exchange Volatility Index – also known as the VIX – had averaged 14.6. By contrast, the VIX has averaged 20.7 since August 2015 market dip.
A persistent pattern
Looking beyond historical patterns, current drivers of market volatility may also make a case for its persistence. The August 2015 volatility spike was driven by a range of factors, including investor concerns about the impact of slowing economic growth in China, plummeting oil prices, and monetary policy uncertainty. These same issues remain in the headlines today and none seem likely to be resolved anytime soon. It’s not just the fact that China’s economy is cooling or that oil prices are low that weighs on investors – it’s the follow-on effects of those trends. In China’s case, the country’s reduced demand hurts commodities exporters. And low oil prices signal headwinds not just for traditional oil-producing countries but, for the U.S. as well.
Monetary policy effects
The Fed’s normalization of monetary policy – its broad plan to increase benchmark interest rates as it sees U.S. economic indicators improve – also has the potential to rile markets. The effect of monetary policy on market volatility is further magnified because of uncertainty about the magnitude and direction of potential rate changes and potential second-order effects they might have on the economy. As of now, the estimated timeline of the Fed’s normalization of monetary policy extends to 2018. It should be noted that this timeline is not a set program of rate increases but an approximation that is subject to change. As results of the most recent Federal Open Market Committee meeting in March 2016 demonstrate, the conditions for raising rates may be more fluid than some thought in the beginning of the announced normalization process in December 2015.
Warning: Experiment in progress
Though the term “normalization” doesn’t suggest it, we have entered an experimental phase in Fed monetary policy. December 2015 marked the first rate increase in a decade and also the first time in many years that the Fed has been out of sync with global counterparts. In fact, the European Central Bank and Bank of Japan have driven key rates in their respective economies into negative territory. There is no certainty that the Fed will be able to proceed with raising rates to more historically normal levels in accordance with its estimates. As recently as mid-February 2016, the Fed futures market had priced in a higher likelihood of a rate decrease by mid-2016 than a rate hike. With Congress questioning Chairman Yellen at that time about the effect of a potential negative interest rate policy in the U.S., a high degree of uncertainty clearly exists. Regardless of what the Fed does next, the U.S. economy is in uncharted territory and potentially volatile market conditions will remain a possibility in the near-term. Investors may want to acclimate themselves to this “old normal.”
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This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
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