Volatility - What Can We Expect Going Forward?
Thus far, 2020 has been quite the rollercoaster in the stock markets. COVID-19 fears suddenly jolted the markets downward in March followed by a significant recovery thus far in April and May. The question on everyone's mind is, what is next? While we cannot predict short-term market movements, we do feel that the higher volatility we have seen this year is something we should mentally prepare for until there is a vaccine or treatment to mark an end to this pandemic. Depending on the estimate, the finish line appears to be at least 12 months away.
What Is Market Volatility?
By definition, volatility is the degree of variation in market pricing over a given time. Historical volatility is the measure of the volatility of past market conditions. The current volatility is the measure of what the market thinks upcoming volatility will be. The most popular measure of volatility in the U.S. market is the Chicago Board Options Exchange (CBOE) Volatility Index or VIX. The VIX index is a real-time volatility prediction based on 30-day S&P 500 Index option pricing.
While the VIX index has only been around since 2004, we still have 16 years of up and down markets to help understand how today compares to recent history, including the Great Recession. The title image of this article shows the total duration of the VIX index (source Morningstar.com). The higher the spike in the graph, typically the more fear in the market, and the more we might expect bigger market swings. While this measure has declined from the March 2020 peak, the futures market is still predicting higher daily market movements than we have seen throughout much of the last 16 years.
What If Volatility Is Lower?
Great! Lower volatility will make the feeling of market movements much less jarring compared to March 2020. We want to make sure everyone is prepared for volatility in the hopes that it does not happen. It is always better to be prepared.
What Should We Do?
Academic evidence has repeatedly shown that it is not possible to consistently time the markets. Since we cannot time the markets, we can prime our expectations of what to expect from the markets. Using this historical data, we can see that over time, market volatility generally subsides. Once the COVID-19 pandemic unwinds and the true economic and societal effects become clearer, the markets should respond with more certainty of the future as well.