On the Brink of a Bubble? Not So Fast

Volatility is likely headed higher, but that doesn't mean we're in a bubble

Oct 9, 2015 at 9:16 AM
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If you watch much financial TV, you probably hear the word "volatility" (or variations thereof) used a bit. As in, "Wow, it's volatile out there," or something similar.

But here's a fun fact: As I type this, CBOE Volatility Index (VIX) is actually down this year. Not down much, but it's down -- as it closed 2014 at 19.20. Now, that's a little misleading, in that VIX popped right near the end of 2014, leading to an inevitable overstating of 2014 volatility results, and making for tough comps in 2015. By most definitions, 2015 has seen an uptick in vol.

The definition I prefer for this exercise is "median VIX." It gives a broader picture of vol, as opposed to a mere snapshot. And by that definition, VIX is up this year. So far in 2015, VIX has a median close of 14.74, vs. a median of 13.67 in 2014.

Both are on the low end, as VIX has an all-time median of 18.05. The best we can say it is: Volatility is trending up, but is still historically low.

Another reason I like medians is that they give us a good picture of long-term volatility regimes. Here's the median of every year back to 1990:


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On this look, we're slowly emerging out of long-term trough No. 3, and likely headed slowly toward a high-volatility regime. The first trough lasted about five years, the second lasted four years. We're basically in "Year 4" now, which suggests that if history repeats, we'll see the trend toward higher vol continue.

It's tough to say what that all means, market-wise. We have literally two kinds of vaguely defined high-VIX regimes. But the behavior on the upslope was diametrically opposite. VIX started trending higher in 1996, but that didn't exactly top the market (nor did Fed Chairman Alan Greenspan's "irrational exuberance" comments around then). We exploded higher for 3.5 more years.

Quite different the next go-round, of course. The vol uptick in 2007 preceded (and predicted?) the market meltdown in 2008.

I'm going to go out on a limb and say we see a higher mean VIX in 2016 than we ultimately see in 2015. But I think it's dangerous to simply assume that's going to coincide with a lower market. For all the "bubble" talk thrown around, we're not close to seeing late-'90s kind of PE multiples (in many cases, the "E" part never happened).  

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

 

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