Mark P. Bernier | Posted on Jan 01, 2018
2017 was a remarkable year in the markets for many reasons, beyond the calendar year returns we experienced. One of the most interesting facets of 2017 was the low levels of volatility, as measured by the Cboe Volatility Index®, better known as the VIX® Index. This measure is based on the price of S&P 500 Index options (another lesson for another day), measures market expectations of short-term volatility, and is sometimes referred to as the "fear index." A high VIX® Index reading has often been synonymous with weak stock markets, and vice versa. In July 2017, the VIX® Index hit its lowest levels ever: 8.84 (the highest level, over 80, was in November 2008). Volatility in the markets increased in the first quarter 2018, though at the time of this writing, the current level of the VIX® Index is more in line with its long-term average, around 20. What has changed in the first three months of 2018 to cause the first market correction in two years and higher levels of volatility?
Markets are forward-looking. In other words, investors base their decision to buy, sell, or hold based on what they expect to occur in the future. When new information or new expectations form that alter the outlook, investors may alter their decision to buy, sell, or hold. As investors attempt to place a value on that new information or expectations, the price of the investment will fluctuate. One source of volatility early in the first quarter was a change in the outlook for inflation expectations. Long-term interest rates moved higher and employment growth was stronger than expected, raising the concern that the Federal Reserve may be more aggressive in raising interest rates this year. This new perception, coupled with some (likely) forced selling by institutional investors and traders in exotic volatility investments, resulted in high levels of market volatility in early February, including some of the largest point (not percentage) moves in the Dow Jones Industrial Average in its history. Domestic stock markets experienced their first correction (defined as a 10% decline from a high) in two years, but recovered much of the decline within 10 business days.
Investors witnessed continued volatility in March, following President Trump's announcement on March 22 of $60 billion in tariffs on Chinese goods to take effect later in the year. Fears of a trade war manifested with investors selling stocks and buying safe-haven assets; equity markets fell by several percentage points and interest rates in longer-term U.S. Treasury securities declined. Selling in large, widely-held technology stocks late in the quarter also contributed to higher levels of volatility.
Market volatility is often portrayed as a negative because of its association with market sell-offs, but for long-term investors, it can create opportunity.