Have Stocks Become Less Risky?
Have stocks become less risky? It certainly feels that way…
1) Annualized volatility in the S&P 500 has moved down to 6.2%, its lowest level since May 2007. Going back to 1928, the volatility over the past year has been lower than 97% of historical periods.
2) Not only has volatility been low, but the market has been higher on a much more consistent basis. Since 1928, the S&P 500 has been up on a monthly time frame 62% of the time. By contrast, over the past 14 months the S&P 500 has been up 13 times, a win rate of 93%.
3) On a rolling 12-month time frame, the S&P 500 has been positive 74% of the time historically. Since October 2010, this win rate has moved up to 96%.
4) The Volatility Index moved below 10 this week to its lowest level since February 2007. This was only the 9th month since 1990 that the VIX has dipped below 10.
Any way you look at it, volatility is very low. At the same time, investors have experienced gains with a much higher level of consistency than in the past. As investors tend to equate volatility with risk and consistency with a lack thereof, many will conclude that risk today is extremely low.
But is this actually the case? Have stocks become less risky?
Count me as skeptical. Nassim Taleb once said: “don’t confuse a lack of volatility with stability, ever.” Low volatility can create an illusion of current stability, but unless it is actually predictive of future stability, it is merely an illusion. If low volatility were predictive of low risk, you would not have seen near record-low levels of volatility in early 2007 when risk was actually at its highest level in decades.
If not volatility, what should investors fear? My view is similar to that of Howard Marks. Investors should fear a permanent loss in capital. A permanent loss can come from the investor (selling out on a decline due to necessity or emotion) or from the investment (Enron, Worldcom, Lehman, Subprime Mortgage Bonds, etc.).
Estimating the probability of permanent loss is far from easy, which is why most investors should focus instead on what they can control: 1) building a diversified portfolio that fits their risk tolerance and timeframe and 2) sticking with that portfolio through inevitable periods of volatility/drawdowns.
The best time to think about #1 and #2 are when times are good – when volatility is low and drawdowns are few and far between. During these “good times,” you can think with a clear head and are more likely to make decisions based on evidence instead of emotion. Times are good today. Get busy thinking.
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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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