Could an Extended Period of Low Volatility Be Ahead?

How stocks have performed after periods of tranquility for the SPX

Senior Quantitative Analyst
Jun 16, 2021 at 9:24 AM
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The S&P 500 Index (SPX) has been extremely calm lately, as stocks carve their way higher. This has led to a collapse in the benchmark’s 20-day historical volatility (HV), which is at its lowest level since before the Covid-19 pandemic started. This week, I will be analyzing how stocks have behaved after these periods of tranquility.

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Diving Into Historical Volatility Brackets

First, I am looking at how SPX stocks have generally performed based on the 20-day historical volatility reading, dating back to 1950. The table below summarizes the returns over the next month based on those parameters.

The latest reading of 7.4% as of Tuesday's close falls into that first bracket of lowest readings. Unfortunately, the average return for the SPX over the next month is the lowest in that bracket at 0.38%. And though the percent positive sits at 60%, that number does not vary much between each bracket. Meanwhile, the volatility over the next month, as measured by the standard deviation of returns, is also the lowest in that column. This makes sense, given the low volatility environment in which this situation occurs.

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I wanted to see if this tendency still held when looking at more recent data. The table below shows the same data, but this time dating back to 2010. The brackets are also slightly different, so that each has the same number of readings. The SPX has performed best since 2010 after high readings for the 20-day volatility. The one-month returns are strongest in those two bottom rows, where the reading is 13.6% or higher. The low volatility bracket shows a one-month return of 0.49%, which is the second-worst bracket in the table. It seems these low readings have generally led to boring underperformance.

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Why Volatility Could Stay Low Going Forward

With volatility falling so fast on the SPX, and with some higher volatility days soon to drop off the rolling 20 days, I predict 20-day historical volatility will soon dip under 5%. The table below shows how the SPX has performed after these occurrences, which have happened 14 times since 1950. The data suggests strong returns over the short term, with the index gaining an average of 1.72% over the next month, with over 85% of the returns positive. The SPX has typically gained 0.74% over that time frame, with a 62% probability of a positive return.

Looking past that, however, these signals show returns that underperform the market. Six months after a signal, the average return and percent positive are both lower than what the market has typically done. Based on these 14 occurrences, volatility is expected to stay depressed.

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For those who are curious, the table below shows each of the signals in the data above. The last signal happened in late 2019, a few months before the Covid-19 pandemic hit. This resulted in a loss after six months, as the SPX was in the early stages of recovering from the initial collapse. In the signal before that, from September 2016, stocks behaved the opposite way as to what is expected after these signals. The SPX fell 1.35% over the next month, but was up almost 13% the following year.

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