Trade & the 1%

Potential trade wars, emerging market concerns and a flattening yield curve are just some of the factors riling markets of late, but our measures of US equity volatility show trading was actually pretty ordinary in the second quarter. Even the VIX itself only has a 16 handle currently, in line with the average for this year thus far and below the annual average of 19.3 since it was created in 1990.

Consider a few other volatility-related points as well:

#1 The S&P 500 gained or lost more than 1%/day in 13 trading sessions during the second quarter, compared to the Q2 average of 13.1 since 1958 (first full year of real-time data). If it seemed choppier than usual, it may be because there were only two 1% days during this period last year. It’s not that the past three months have encountered high levels of volatility, but that last year was unusually quiet.

#2 The S&P has risen or fallen by 1% or greater on 36 days so far this year. From this perspective 2018 has been more volatile than usual so far. There have been fifty-three 1% days on average each year over the past 6 decades, and we are past the half way mark only half way through the year. This was due to the first quarter, however, when there were 23 one percent days compared to the Q1 average of 13.2. A lot of that stemmed from the ETF vol meltdown in early February.

Even still, at this rate the S&P only needs 17 more 1% days over the next 6 months to meet the annual average of 53. If the market continues to experience average volatility, the back half of the year will not only reach, but probably exceed that level. The average number of 1% days is 13.1 in Q3 and 13.9 in Q4 for a potential total of 27 more 1% days this year.

#3 Bottom line, if you’ve felt like the market has been choppy recently, expect it to either stay the same or increase in the back half of the year. August and October, for example, are the most volatile months of the year. Those are the 2 months in which the VIX has reached an annual peak the greatest number of times since 1990 (5 times each). The VIX has already climbed as high as 37.3 this year in February, or a little over double its current level.

We’re not trying to scare you and remain positive on US equities for 2018, but it may not be an easy finish to the year especially with the issues we raised at the top of this note. Trade will likely take at least the rest of this year to iron out, and we will grow more cautious going into 2019 especially if the 2-10 Treasury yield spread continues to narrow at its current rate.

With all this said, there is a silver lining: President Trump will not want to stir up the markets or alienate his base too much heading into mid-term elections in November. That’s likely why he said he wants to wait to sign a new NAFTA deal until after the elections, for example. The president is walking a tightrope on trade: delivering on a campaign promise while not overly spooking equity markets. One percent days will do a lot to inform how quickly he can complete this transit. And what the destination point might be.