Volatility in the Year Ahead

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Volatility in the Year Ahead

Despite trade wars and concerns about global economic growth, it’s been a relatively quiet year for US stocks in terms of volatility. Even this past Friday the VIX – Wall Street’s fear gauge – ended with only a 12 handle compared to the long-run average of 19. The low for the year was also as recent as the end of November at 11.54 on 11/26.

So how unusual is this year’s low volatility and will it mean revert in 2020? A few points:

  • We pulled the average VIX for every year back to when it was created in 1990.
  • This year’s average VIX is 16 thus far versus the long-run average of 19.
  • Given that the standard deviation is 6 points, this year’s volatility is still within one standard deviation of the average. So while it is below the long run mean, it’s still within normal bands.
  • That said, years with a below average VIX cluster together. There were 6 years with below average volatility from 1991 through 1996 and 4 from 2004 to 2007. The current period has been the longest continuous streak, with a below average annual VIX each year since 2012 (8 years).
  • The annual average level on the VIX has been 16 after a year with a below average VIX level.

The upshot: years with lower than average VIX levels tend to be followed by another year with a below average VIX as they string together.

Another way we measure volatility is by tracking the number of days the S&P 500 rises or falls by 1% or more. Here’s where the S&P stands by this measure:

  • The S&P 500 has increased or dropped by 1% or more on 38 days this year compared to the annual average of 53 back to 1958 (first full year of data).
  • This year’s number of 1% days is within one standard deviation (32 days) of the average. So just as with the VIX, the number of 1% days this year is below average, but also common enough.
  • The S&P 500 has had a lower than average number of one percent days in 55% of years over the last 6 decades, so lower volatility than the average is actually more common than higher volatility. There are typically 39 one percent days in the year after a year with lower-than-average volatility. In other words, years with lower than average volatility are usually followed by another year with below average volatility as measured by 1% days.
  • That said, volatility tends to be cyclical. Our bar chart of annual S&P 1% days after this section shows a clear pattern over the last six decades. Large market swings happen during the start of a bull market, abate and then rise again towards the end of annual sequential gains in US stocks.

    This last cycle has been more mixed than usual. The post-Great Recession low will likely be 8 one percent days in 2017. Last year was more in keeping with late cycle norms at 64 one percent days versus the annual average of 53, but this year is running behind at 38.

Bottom line: years with a below average number of 1% days tend to be followed up with the same pattern in the year after, but volatility should start ramping up given that it is late in the economic cycle.

In sum, US stock market volatility has been lower than average in 2019, but not drastically low from a statistical standpoint. Lower than average volatile years tend to cluster together, so 2020 could also prove calm as well. That said, volatility usually picks up towards the end of a business cycle. Whether low volatility extends into 2020 will come down to a continued US-China trade resolution to quell fears about slowing economic growth, and the Federal Reserve remaining patient and dovish.