Where has all the volatility gone?
Australian and US equity markets have been in a happy mood of late. The index seems to be able to move only in one direction (up), and volatility has dropped to levels not seen for some time. The picture below shows the US market; the Australian market is not too dissimilar.
This is a fairly strong negative correlation between volatility and equity market returns – when equity markets fall, they often do so with vigour, and that translates into high volatility. On the other hand, when volatility disappears, the equity markets can feel very comfortable and safe; the sort of conditions that make us all want to slip off our shoes and go for a dip.
Of course, we’re looking in the rear view mirror here, and when we put money into the equity market, we should care about its future volatility, not historical. Unfortunately, we can’t tell much about future volatility from this analysis. However, noting that volatility comes in clusters we can make the following helpful predictions:
- Volatility will remain low for a period of time, the length of which we can’t predict; and
- When that period expires, volatility will move higher – possibly sharply higher.
The point of all this is simply to say be wary of extrapolating the past too far into the future. The market is singing a beguiling tune for now, but, a bit like the sirens of Greek mythology, this is one of the ways the market can lure unwary investors onto the rocks.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
