If there is one thing that all investors can agree on from the first quarter of 2018, it is that volatility in the markets is most certainly back. But what does that mean, and why is it such a critical data point for market participants?

Volatility, as defined by most investors, refers to a measure known as the VIX, which is actually the ticker symbol for the CBOE Volatility Index, an index constructed from both call and put options on the S&P 500 Index.

It is intended to be a leading indicator for market fluctuation over the next 30 days, and as such the value tends to move higher as investors become increasingly concerned about potential weakness in stock market prices.

The VIX has been enjoying a dormancy of sorts over the last several years, particularly in 2017. While historically a VIX level under 20 indicated calm in the markets, in 2017, it spent much of the year under 15, with only two meaningful moves higher – both still under the 20 mark.

With the VIX anchored at these low levels, and very little risk aversion observed in the market, there were a number of products that were created that allowed investors to earn returns on moves lower in the VIX. The issue with these strategies was apparent in early February, as a spike in the VIX following the bond market’s reaction to strong January wage growth created selling pressure, which only proved to move the VIX higher, and compound the effects of forced selling of these inverse VIX products.

Despite the dislocation produced by this selling, however, the moves in the VIX in February appeared to have ushered in a period with levels of volatility that are closer to historical norms. While we acknowledge the benefit of using this “fear gauge” to measure sentiment, it is just one part of the mosaic for us, and frankly, we believe that a modest increase in volatility can result in the creation of opportunities, particularly if considered as part of our thoughtful portfolio construction process.

CBOE SPX Volatility Index
Source: Bloomberg, 4/12/18
 

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Q2 2018 – Economic and Market Perspective
 

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