It’s all relative, folks.
Thus far in the new year, there have been 25 trading days, of which six days have had moves on an absolute basis of over 1.5 percent (both positive and negative). During 2021 the average number of six daily moves over 1.5 percent during the previous 25 days was two, so, yes, volatility has certainly picked up.
Realized 25-day annualized volatility at the close of today’s trading was 19 compared to an average of 12 in 2021 and 27 in 2020. The VIX closed at 22.86 today, which seems a bit low to us.
The extraordinary volatility of 2020 was driven by the COVID stock market crash in February/March, the most volatile 25 -day period in post-war stock market history. The VIX failed bigly to anticipate future volatility and was at 14 when the bear market started on February 19th.
Too many yield-seeking vol sellers during quiet times have weakened the VIX as an anticipatory signal, in our opinion. The VIX, expected volatility based on option prices over the next 30-day period, peaked at 85 in early April 2020, along with our measure of realized volatility.
In early April 2020, the 25-day realized volatility increased to over 90, absolutely stunning, and illustrated in the following chart.
The stock market anticipated the largest quarterly economic collapse in the county’s history, coming in Q2 2020, where real GDP fell 37.5 percent at a compounded annual rate. Interestingly, the S&P bottomed on March 23rd just before the start of Q2 as it heard the footsteps of the most massive global fiscal and monetary stimulus in history.
The 2020 economic and stock market collapse was most likely an aberration, not to be repeated. We seriously doubt global policymakers will flip the lights off on the economy ever again. Never say never?
We expect volatility to remain elevated as the Fed starts to turn the monetary screws in March, but they are a long way from neutral. If the past is prologue, they will move at a snail’s pace.
At some point during the tightening cycle, something will break, most likely the equity market first, if the Fed doesn’t get spooked by increased market volatility and lets inflation run, which will be political death for the political party in power. Think 1980, Jimmy Carter, and Paul Volcker.
Jay Powell is no Paul Volcker and will have to earn his inflation-fighting bona fides.
Investors should certainly have some dry powder, lots, in our opinion, to put to work on the break. The S&P500 is up 112 percent over the past five years, and since 1960, second only to the move in the mid to late-1990s.
Valuations are extraordinarily elevated, and the market is overdue for a big dipper. Nobody knows the timing of a major correction, which will likely be determined by how sensitive the market is to the coming monetary tightening cycle and how far and hard the policymakers have to squeeze to bring inflation under control.
Equities Are The Place To Be In The Long-Term
There is no doubt, however, equities are where wealth is built over the long-term, reflected in the following chart.
That is one scary chart and really should be scaled by taking the log of the S&P levels.
Getting Out Too Early
I sold out at 3200, leaving 1300 S&P points on the table, which would have resulted in my firing if I were not in the fortunate position of being independent. I also have trader status with the IRS, which cannot be revoked, so taxes are not an issue in my decision-making. My positions are marked-to-market at the end of the year, taxed on the mark, even if I haven’t sold or covered the position.
However, most investors and portolio managers are not in my position and have to remain almost fully invested due to career risk and fear of missing out (FOMO). I have always equated FOMO investing to fearing missing the four days of partying on the Titanic after it left the dock. No thanks, not my cup of tea, though I do get the trade. I really do, even in crypto.
Putting the big fail of getting out too early in the past, I am currently positioned in my happy place and sleep well at night (even though I am a chronic insomniac). I hope you all are too, that is in your happy investing place.
Scalping is the word for me. Stay tuned.