Investing Advice: How to Handle Higher Volatility

Posted On March 20, 2018 1:13 pm

Monday saw all the major indices incur a decline of greater than 1.5%.  This will be 21st time this year the S&P 500 has recorded a move of 1% or more. This stands in stark contrast to all of 2017, with just 9 such days. By various measures, it was the least volatile year on record. Today’s investing advice is tailored towards 2018’s radically different environment.

Indeed this increase, or as I called it, a return to normal volatility, can be seen by the fact since February 1st the VIX has not dipped below 15 and has averaged a 19 reading.   During 2017 the VIX spent a full 195 trading days below the 12 reading and crossed 15 a grand total of three times.

If you had told me, or any active trader, that the market would have such a significant, and so far sustained, increase in volatility we’d have said, “bring it on.”

But you know the old saying “be careful what you wish for?” Now that it’s here, how do we handle it?

A recent report from Blackrock has some investing advice for Navigating the New World of Volatility.

Our last two blog posts expressed an unambiguous expectation that volatility would rise on a cyclical basis and we remain convinced that the higher levels of realized volatility we’ve experienced so far this year will be a lasting thematic component of the investment landscape for the foreseeable future.

A volatility regime that feeds on itself

Moreover, we firmly believe that the recent spike in volatility is creating a reflexive cycle. In other words, the heightened volatility has itself become the news from which investors take their investing cues, which is accentuating the already acute human emotion of fear associated with investment losses. In turn, positioning has become more defensive and markets have become less liquid. Ultimately, the investment backdrop is being defined by the higher realized volatility and this perpetuating cycle is becoming entrenched.

This human fear reaction-function is exacerbated because traditional hedges are no longer working as they have in the past. Today’s risk models are built on some of the strongest asset correlations of the last century, which have suddenly broken down. These correlation shifts are feeding the new reflexive volatility cycle as risk-models have to be re-calibrated, a phenomenon we expect to continue all year.

Longer-term risks remain, with demographic decline

Meanwhile, we remain focused on the secular themes that we believe dictate durable investment out-performance. For instance, we remain concerned over the troubling demographic trends that dominate developed market (DM) economies and will increasingly impact emerging market (EM) economies as well. Potential economic growth is following these downward sloping demographic curves, which, when married to onerous debt burdens, raises the potential for economic stagnation.

At the same time, while the worry now is over a wage-driven rebound in inflation, we are far more sanguine based on our long-held belief in the secular dis-inflationary tendencies that result from ubiquitous technology-driven innovation. Moreover, we strongly believe that future corporate investment will not be about expanding capacity, but about improving efficiencies and productivities through computing, software, and research and development.

 Related: Why Bank of America is Worried About the Market

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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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