Stocks quoted in this article:
I think it's safe to say that at least as far as big-caps are concerned, everyone knows we're in a churning market. And it took a while, but that churn is now characterized by drifting volatility, as proxied by the CBOE Volatility Index (VIX) and all its tradable offshoots.
But is this just the volatility calm right before the volatility storm? Andrew Kassell, a.k.a. @Andrewunknown on Twitter, says "yes" in a post over on See It Market. He looks at the S&P 500 Index (SPX) through the lens of Bollinger Band widths.
As Andrew reminds us, Bollinger Bands are drawn around a moving average (in his study, the 20-day moving average) to show a range above and below the moving average. Pretty much all BB's default to two Standard deviations above and below, and that's what he uses for his study. The width is the distance from the two bands, with the tighter the width representing the lower the realized volatility in the underlying.
Anyway, he annotates a chart of the last decade with vertical lines showing where the BB width (BBW) has fallen below 0.1 (I'm not sure exactly the unit … think of it as a %). As he notes:
The vertical lines denote 12 occasions over the last 10 years where the BBW has troughed below a reading of 0.1. Over this look-back period, these are the points where historical volatility has been at its absolute lowest. At 0.06, the current (and 13th) trough is the lowest and most persistent since mid-2006.
The big question, though, is what that means going forward. There's an adage that says low volatility begets high volatility … and vice versa. Well, his numbers back up that adage.
- The range the S&P puts in following the BBW trough is usually a multiple of the range preceding it. SPX gets much more volatile.
- In the 5 weeks following these troughs, the S&P is 2.8x more volatile.
- In the 10 weeks following these troughs, 7.5x more volatile.
- In the next 20 weeks, 8.5x more volatile.
It's great stuff and pretty intuitive. I can't do it justice with the couple clips I included here. I would just like to add a couple thoughts onto the results.
One is not to forget that the increased volatility he's seeing is in relation to the volatility in the trough period. An increase in volatility off a low as measured in percentage terms can look way more impressive than it would when viewed in absolute terms. Say we're talking 10-day realized volatility. If it lifts from 8 to 12, that's a 50% jump. Or I should say, a 50% jump!!! But when measured in absolute terms, it's a 4-point lift, which is rather unexceptional historically. And a realized volatility of 12 is very mediocre. So a mean-reverting uptick in vol. really only gets us from trough to "eh."
Another is that we're only in a volatility trough as defined by Big Caps and VIX. As we've noted often recently, Russell 2000 Index (RUT) realized volatility and implied volatility have had a relative explosion in 2014.
I do agree with his thesis. Big-cap volatility will likely see something resembling a mean-reverting "spike" in the next couple months. I'd guess there's some form of volatility baton-passing from small to big coming down the pike. I don't believe it will be cosmic, though, rather I'd expect SPX vol. to tick up from the trough to a more "normal" reading.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.