Will Donald Trump Break the VIX?

The Trump presidency is likely to coincide with with a meaningful VIX lift -- but don't blame Donald, says Adam Warner

Jan 16, 2017 at 10:00 AM
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Greetings! I haven't chimed in for a while, but you have all done a great job keeping the CBOE Volatility Index (VIX) in check in my writing absence. But with an imminent cosmic Trump sea change on the horizon, we all have questions. Such as this:

"Since the guy's a bit of a wildcard, can we expect to see a steady volatility ramp (or endless spikes)? Or does the likelihood of a 3 a.m. Twitter rant against Pyongyang just get priced in during one big fell swoop, and it's smooth sailing from there?"

Short answer is yes, I expect volatility to lift. But I don't necessarily think it will happen because of President Trump, per se. Or, a better way to say that is: I would expect a rising volatility trend in the next four years, Trump or not. He may (OK; he will) exacerbate that, but given we have no control universe where he's not president, it will prove difficult to measure.

It's rough to see much into the VIX's future. We are all generally guided by the recent past. In fact, the single best way to "guess" at the market's volatility assumptions going forward is to look at the current realized volatility backdrop... and then add a few points, because the market net-net almost always expects higher volatility tomorrow than it sees today. Don't believe me? Watch financial TV for a day, and jot down any time someone gets asked what they see for volatility going forward. Dollars to doughnuts, they expect it to go higher.

Don't have the patience to watch much financial TV? I don't blame you. Good thing there's an objective way to gauge future volatility expectations. Just look at VIX futures! Here's the current VIX term structure, courtesy of VIX Central.

vix futures term structure 0112


Volatility is definitely going to lift! VIX futures are all-knowing, and they see upticks as far as the eye can see. But alas, as we just noted, the market always expects higher vol out in time. And that's especially true at low VIX levels.

Here's Jan. 6, right after the monthly jobs report came out, versus two other moments in time with similarly low VIX levels. One is in August 2016, with the election season about to heat up. The other is in August 2015, with virtually no political volatility attached (because, as we all knew, the Trump Show would go away soon and Jeb and Rubio would fight it out for the nomination).

vix futures historical prices 0112


Our current curve sits between the older two, which makes some sense. The best analysis is that the market prices in some "Trump Vol Premium," but nothing all that noteworthy.

And remember, volatility futures are almost always wrong. They have predicted about 1,000 of the last 10 volatility spikes. They also only predict lasting VIX trends. Short-term VIX pops can and do occur somewhat often; maybe two to four times, in a typical year. A VIX future technically doesn't hedge you against that, unless you time the VIX pop almost perfectly (e.g., owning September VIX futures won't do you much good if it pops in April).

What's more, VIX futures won't help much in a very short-term, Trump tweetstorm-related vol pop. So I'm going to throw all of this out, and lay out my volatility expectations for the next four (gasp) years.

The uncharted waters we now face will likely produce more frequent VIX pops than we are accustomed to seeing. But that may have happened anyway. That's because, in the long-term picture, we are quite overdue for a more lasting VIX pop, Trump or not. Here's VIX back to 1993, using the 30-day moving average in order to smooth out the fluctuations a bit.

vix 30 day moving average since 1993 0112


We tend to move in volatility "regimes" of four to six years. We started in a bit of a low regime, which begat a high regime in the late '90s and early '00s. That switched, in 2003 or so, into about four years of low VIX, then about three years of high VIX.

Long story short, we're now about six to seven years into a low VIX regime.

This is all very inexact, of course. Looking back with the benefit of time, perhaps the high VIX regime that started in 2007 really lasted into 2012. That means we're "only" five years into low VIX... which still suggests a lasting volatility storm will come soon.

So, I'm going to make some general predictions here.

The median VIX, over the course of forever, is 17.91. In 2016, the median was 14.31 -- similar to the sub-normal levels of the last few years. I predict that number moves higher in 2017, and trends higher still over the next few years.

I will not predict how often VIX makes short-term spikes, or remotely when they occur. They take us by surprise, almost by definition. But I do expect we see them more frequently going forward.

We tend to correlate all market moves to something news-related. And since Trump will remain in the news, said spikes may correlate to things he does, or says, or tweets. But it's likely more a byproduct of a rising volatility tide that would have happened anyway.

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

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