Vanguard: Where’s the Volatility?

One of my favorite commercials of all time was the Wendy’s ad where the size of the burgers from competitors was criticized. The famous line “Where’s the beef?” has stuck in my head ever since. Today, I read the paper and see headlines proclaiming volatility, volatility, volatility, and I can’t help but hearing that tagline in my ear, “Where’s the volatility?”

Since the start of 2012 through the first few weeks of 2013, stocks have enjoyed strong returns, coupled with modest volatility. Indeed, despite the headlines stemming from Europe, the uncertainty leading up to the U.S. presidential election, and the 11th hour aversion of the “fiscal cliff,” U.S. equities only experienced minor speed bumps on their path toward an average 21% total return.

Of the 274 trading days, only 7 saw prices move more than 2% and, of those, only 3 were days when prices fell by more than –2%. Compared with long-term history, those 7 days are less than half the average (17 days) for 2% moves in a calendar year. In addition, VIX (the CBOE Volatility Index, based on S&P 500 Index Options)—the so-called “fear gauge”—has fallen to levels commonly associated with tranquil markets. In fact, on January 18, VIX fell below 13 (off –31% since year-end 2012), a level last achieved in mid-2007. [Dow 14,000: The Death of Volatility ETFs?]

Regardless of the measurement used for volatility, it is important to understand that market volatility is primarily driven by significant and unpredictable changes in the global macroenvironment. Because volatility ebbs and flows with these unpredictable macrodevelopments, volatility itself can be very volatile as new information is priced into current market values. As we have seen throughout history, the regime at any moment can change and change significantly in a short period of time.

For example, in the months preceding August 2011, the investment markets were experiencing positive returns coupled with low levels of volatility. At the same time, there was a fast-approaching event, known as the debt ceiling. The debt ceiling debate eventually led to a credit-rating downgrade by a major rating agency.

Then on August 8, the next trading day following the downgrade, VIX spiked to 48, more than two times greater than the long-term average since 2000, and stock prices fell rather quickly. The following months were marked by a fairly extended period of heightened volatility in the equity markets until year-end when it swiftly and significantly declined, as shown below in the figure. The net result? For 2011, the S&P 500 Index returned only 2% (if you reinvested dividends), coupled with periods of significant volatility.

So where are we today?