5 months ago • 2 mins
Volatility just wouldn’t be very, umm, volatile if it always stayed at the same level. This year, it’s been declining sharply in stock markets, dropping to levels that are usually seen in times of macroeconomic calm and complacency.
Now, don’t get me wrong, there are plenty of reasons why the volatility index, or VIX, (also commonly referred to as the market’s “fear gauge”) has been falling: the S&P 500 has been extremely well-behaved, macroeconomic data and company earnings have surprised positively, the stress in the banking system has faded, the rise of AI has sparked optimism about the future, and overall sentiment has simply become brighter. And, interestingly, this follows a fairly standard pattern for the VIX, which often starts the year on a high note and then cools down by summer.
But don't get too comfortable: the same seasonal trends that have been pushing the VIX down could soon be pulling it back up. If you look at the chart, you’ll see that volatility usually hits a low in July, before rising through October (and that’s even if you exclude 2008). Now, just because that's the most well-trodden path, doesn't mean it's the one the market will follow this year: the reason for this pattern is still a bit of a mystery, after all. But investing is all about piecing together different pieces of the puzzle and trying to gain a small edge.
Right now, the odds appear tilted toward an increase in volatility. There’s a seasonal trend, sure, but it's also unlikely that economic data or company results will continue to surprise so positively. Instead, what’s more likely is that we’ll begin to see some of the harsh economic consequences of the recent run of aggressive rate hikes, and, ultimately, that may chase away some of the optimism and complacency that investors have had.
This doesn't mean you should panic and expect a stock market crash, or rush to buy a volatility ETF – those can be pricey to hold onto, and unless your timing is spot on, you're probably not going to make a profit. But it does suggest that it might be time to consider some protection against a potential market drop (low volatility will make the price of that protection very cheap), and maybe play it a bit safer for a while.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.
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