Volatility and Mean Reversion
“Don’t confuse lack of volatility with stability, ever.” – Nassim Taleb
Volatility is low. How low?
Over the past month, the Dow Jones Industrials Average has traded in a range (from high to low) of 1.4%. Going back to 1970, that’s the least volatile period in history.
At 2.2%, the same range for the S&P 500 is not the lowest ever, but it’s close.
The Volatility Index (VIX) closed yesterday at 11.26, lower than 97% of historical readings going back to 1990.
What does this mean for markets going forward?
Not as much as one would think, as I wrote about last July when the VIX was at a similar level (below 12). The forward S&P 500 returns from the lowest VIX decile, while slightly below average, are still strong.
Low volatility, then, is not by itself a contrarian sell signal. That doesn’t mean that stocks have never gone down following periods of low volatility (they have), just that they don’t have to go down and are much more likely to go up.
Perhaps the only intelligent thing that can be said about periods of extremely low volatility is that they tend to be followed by periods of higher volatility. The opposite is true as well as illustrated in the table below.
Jeremy Grantham once said that “profit margins are probably the most mean-reverting series in finance.” I respectfully disagree. That prize goes to volatility. And given its extremely low level today, we should be prepared for it to rise.
To download our research on stocks, bonds and volatility, click here.
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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