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Harness Volatility & Create Opportunity

While the CBOE S&P 500 Volatility Index (VIX) has long served as a volatility yardstick for investors, the index again stepped into the limelight in March of 2020 when it spiked to its highest level ever. Just as was the case last year, investors are needing to tap into their fight or flight instincts early in 2021. And while you may be tempted to choose the latter, there’s a case to be made for fighting through volatility.

First, a quick VIX crash course. The VIX measures the implied volatility of the S&P 500, but it isn’t calculated using the prices of the equities that make up the index. The level of the VIX is actually determined by the number of options contracts bought and sold on those underlying securities — which may be an indication of hedging and bearishness, but not necessarily a sell-off.

Despite, and in part due to recent volatility, the chart below shows that major indices are much higher over the past year. This illustrates that volatility more so means variability, and not necessarily losses.

Dow, S&P 500, NASDAQ 1-Year Chart as of March 10th, 2021

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Because of record-high returns and record-low VIX levels during the market’s recent historic bull run, investors have developed rosy expectations for both of these metrics. In reality, the average VIX level since its introduction in 1993 is 19.5; the average in 2020 was 29.1, but currently sits at 22.7 a few months into 2021.

CBOE Volatility Index VIX as of March 10th, 2021

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While current volatility is high in comparison to recent years, the VIX has calmed down considerably since the early 2020 spike. So why does it feel like the markets have never been more volatile?

The storylines driving today’s volatility are all familiar sound bites: rising interest rates jeopardizing the future of equities, as possible tightening of the Fed Funds rate is rumored; lingering COVID-19 effects are dampening growth in some sectors, thus deferring capital expenditures; and equity valuations are reaching historically lofty levels.

S&P 500 Performance vs PE Ratio, as of March 10th, 2021

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Or perhaps it’s because both retail investor exposure and activity have never been higher, according to NASDAQ. The trend really took off after most brokerage firms eliminated trading commission fees at the end of 2019. As everyone signed up for brokerage accounts, everyone bought; as everyone bought, stocks went up. Perhaps the somewhat disconnected recovery in stocks combined with above average VIX levels has us all wondering what will stick?

The chart below shows a bull market spanning the last 5 years. Despite a pair of spikes at each end of 2018, the bull market persisted with relatively little volatility. However, those ceilings from 2018 have become the VIX’s new floor after COVID-19, and continue to persist despite the major indices setting record high after record high.

S&P 500 vs VIX, as of March 10th, 2021

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So what does all this mean for advisors and their clients?

By changing your perspective on volatility, you might see it as an opportunity to dive deep on equities, to look for those with solid fundamentals that have fallen out of favor. With investors actively taking opposite positions on any single equity — a rare occurrence in the last 10 years or so — fundamental analysis and market monitoring are as important as ever in making smart investment decisions.

Speaking of market monitoring, there are nearly 100 VIX indexes available in YCharts in addition to over 80 VIX indicators to help you stay ahead of volatility. There are also ways to play the VIX directly, through VIX ETFs. Some VIX investment vehicles available in YCharts are:

iPath B S&P 500 VIX Mid-Term Futures ETF (VXZ)

iPath B S&P 500 VIX Short-Term Futures ETF (VXX)

ProShares VIX Mid-Term Futures ETF (VIXM)

ProShares VIX Short-Term Futures ETF (VIXY)

ProShares Short VIX Short-Term Futures (SVXY)

Volatility may be here to stay, but it’s not synonymous with losses. Finding the winners of 2021 amidst the rotating headlines may require a little more digging, but they’re still out there.

 

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