Despite the flurry of headlines, market volatility has been extremely low of late. Given how quiet things have been, in addition to the market’s expectation of higher upcoming volatility, should we expect things to pick up from here?
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Despite the flurry of headlines over the last couple of months on earnings, tariffs, and potential rate cuts, actual market volatility has remained relatively muted. In fact, it’s been over a month since the S&P 500 (SPX) has gained more than 1%, while it’s been over two months since we saw a 1% down day. One of the most common measures of volatility is the CBOE SPX Volatility Index (VIX), which is the expected annualized standard deviation of returns over the next thirty days. The VIX has fallen to its lowest levels this year near 15, down from its peak above 60 in April. While current levels are below its average of 18 to 20, it’s still notably higher than where volatility has been recently. Realized volatility over the previous 30 days, which is the actual annualized standard deviation, is at a historically low 5.9. Given how quiet things have been, in addition to the market’s expectation of higher upcoming volatility, should we expect things to pick up from here?
Historically, the VIX tends to overestimate volatility over a coming period, so it’s normal for it to be higher than trailing volatility. That said, the current difference between trailing realized volatility and VIX is in rare territory, as the ratio of the VIX to realized volatility is in the 98th percentile with a reading of 2.62. A larger expected pickup in volatility has been constructive when looking at forward returns, as the 10th decile with the highest ratio has seen some of the best performances, especially over the next three months.
Generally, the market also does better coming off of quiet periods, apart from the most volatile times that usually happen near market bottoms. Presently, the 30-day volatility for the S&P 500 is below 97% of other instances. Looking at the forward returns of the S&P 500 depending on its recent volatility, our present situation would place in the 1st decile, which has historically seen stronger returns than average. Additionally, that group has seen the lowest next 30d volatility at 9.42, meaning that quiet periods are more likely to be followed by further quiet periods.
Humans inherently dislike uncertainty, especially when it comes to money and the potential for downside. When the VIX is significantly higher than recent volatility, like it currently is, then it might be an indication that the market is overly fearful of uncertainty. Additionally, environments of recent stability are more likely to continue that stability, which is another positive in favor of domestic equities.
