Earnings Season Kicks Into High Gear With Volatility At Record Low Levels

Do you remember August of 2017; it was only a few weeks ago? It was being heralded as the month that volatility would come back with a vengeance and after a rather subdued summer in the markets. Cries for a revisiting of August 2015, where volatility spiked from the low teens to the low 50s were resounding in the market place and on social media platforms. But it never came to be. As September rolled around, doomsayers feared the major averages had stretched far beyond historic price to earnings (PE) multiples and as geo-political tensions were heightening between North Korea, the United States and the U.N. Security Council. Again, these doomsday calls that would desire to see a market pullback of sorts and a spike in volatility fell on deaf ears. The major averages climbed higher, volatility sank into a period of historically low levels and doomsayers were cast aside in favor of improving economic and market sentiment. 

The summer and fall months have expressed record low levels of volatility in the marketplace. September volatility averaged 10.44 on the VIX and was the lowest average level for the month of September VIX on record.

 

Such record complacency in the markets is not just a factor of investor exuberance, but also a factor demonstrating just how much the landscape of the investor world has changed. From the proliferation and abundance of ETF and other passive investment vehicles to global central bank interactions with the financial markets; the world of investing has evolved to express a volatility loop that compresses lower with time. Think of the volatility loop as a big oval that compresses itself along the x-axis over time. The theory of “reflexive volatility” that has been chronicled for years, and more recently months on end, doesn’t’ allow for such a different perspective. Volatility “experts” express a belief that aligns with a circular volatility loop whereby what falls will rise reciprocally in kind. In some aspects of VIX language this is known better as a cyclicality that results in mean reversion. This would result in a beautifully round circle of volatility or VIX reading. Artemis Capital’s Chris Cole, bears no recognition of this potential model whereby volatility can still be reflexive, but to a degree that the volatility loop is compressed over time and until the true loop is recognized by an oval shaped loop. Let’s take a look at a statement Mr. Cole offered to the New York Times in a recent interview: 

The fact that everyone has been incentivized to be short volatility has set up this reflexive stability — a false peace,” he said. “But if we have some sort of shock to the system, all these self-reflexive elements reverse in the other direction and become destabilizing as opposed to stabilizing.

In terms of the volatility loop, I’m of the opinion that it is generally best to think of the reflexive nature in the shape of an oval as opposed to a circular loop. Such a hypothesis is actually in line with the recognition of the natural order of volatility and expressed in the long-term VIX curve. Moreover, along the Y-axis volatility moves higher and lower. As such, the shape of the VOL loop may look something like this: