Where did the stock market volatility go?
Low. Real low.
2016 was not a volatile stock market year, although it felt that way to many. But 2017 has thus far been so tranquil, it's been hard to miss.
- The annualised volatility of daily returns of the market over 1997-2016 was 19.8%, with the least volatile quarter in that period being the fourth quarter of 2006 (at 8.0%). Each of the first two quarters of 2017 were below that watermark.
- On 30% of trading days from 1997-2016, the market moved either up or down by more than 1%. That happened just four times in the 125 trading days of 2017 so far.
And expectations regarding future volatility (over the short term at least) seem to be similarly benign:
- The average value of the CBOE VIX was 21.0 over 1997-2016, and the median 19.5.2 Over the first half of 2017, it averaged 11.6.
- On 7 days in May and June the VIX closed below 10. The closing value of 9.75 on June 2 was the lowest since 1993.
Stormier times ahead?
The current volatility regime is a favourable one for investors. But it does not seem likely that this abnormal quietude will last forever. The U.S. stock market is expensive by most valuation measures, and potential triggers of instability are not hard to identify.
And as the serenity persists, it may even sow the seeds of future turmoil. Market stability can increase investors' risk appetite and encourage risky behaviour. Such behaviour – especially if leverage is involved – can end up having to be unwound when market conditions change, and that activity in turn can transform a small increase in volatility into a big one. That may be one reason that, as Mike Thomas noted in a post in January, “shifts between [volatility] regimes, when they occur, tend to occur rather rapidly.” Complex markets are inherently fragile.
There's no telling how far out on the horizon the storm clouds lie, but it would be a mistake to assume they aren't there.
1 Based on the Russell 3000® broad market index.
2 The Chicago Board Options Exchange Volatility index is the most widely-used measure of expected stock market volatility, and is derived from the prices of options exercisable at a thirty-day horizon. I provide both an average and a median value because the distribution of values is significantly skew. The current calculation methodology was introduced in 2003, and data before that date represent back history. The average value from September 2003 to the end of 2016 was 19.1 and the median 16.3.