The S&P 500 index is down 5.75% year-to-date on the close of February 3, 2014.
The S&P 500 index was up 6.2% year-to-date on the close of February 1, 2013.
That may be hard to believe, given the dramatic search for answers among the trading community in 2014. But in the context of the past year, the volatility in the past month has not actually been abnormal. What has been abnormal is that the volatility has occurred on the downside, rather than the usual upside surges that we’ve seen. In fact, the S&P 500 moved more than 5% higher in less than a month on many different occasions in 2013. That’s a volatile move, but feels less so when it happens as a series of small daily gaps to the upside, rather than the swift drops to the downside. As usual, escalator up and elevator down.
In other words, volatility in the S&P 500 has not been as low as the VIX suggested for the past 2 years. Daily close-to-close volatility has indeed been subdued. But when we consider the size of the monthly moves in both directions, volatility has actually been much higher during the recent bull market compared to the 2003-2007 bull market. For example, here is 10 month realized volatility in the SPX index over the past 10 years:
Monthly volatility has been much higher over the past 4 years compared to the very low monthly volatility from 2004 to 2007 (the red line is drawn around the 9 level, which was the high until that bull market ended).
I actually discussed this phenomenon in my Macro Wrap in August of last year:
Meanwhile, the VIX has remained below 20 for essentially all of 2013. The only other years in the past 15 years when the VIX had a similar profile to 2013 (with VIX below 20 for most of the time) were 2004, 2005, and 2006. So how big were the price moves in those years?
- 2004: The S&P 500 index started the year at 1112, and ranged between 1060 and 1214, a range of -5% to +9% for the year
- 2005: The index started the year at 1212, and ranged between 1136 and 1276, a range of -6% to +5% for the year
- 2006: The index started the year at 1248, and ranged between 1219 and 1432, a range of -2.5% to +14.5%
But those ranges were for the entire year. Here’s the thing about 2013 – we’ve already had a range of almost 20%, with 4.5 months of trading still to go.
When we consider that the S&P 500 ended 2013 almost 30% higher by the end of the year, the possibility that index options prices have been priced too low becomes more apparent. Even after the recent spike in the VIX in the past couple weeks, the Dec 31, 2014 at-the-money straddle ($174 strike) is currently priced at around $23.25. That implies a break-even move of about 14% between now and the end of the year. Compare that to 2013’s “volatility”, and it seems downright cheap by comparison.
The U.S. stock market has been much more volatile by monthly or yearly measures than by the traditional daily measures. In that sense, the recent move lower is hardly an outlier. Human nature is human nature though, so we all frantically search for explanations when our account value is going down rather than up.