One thing that most investors don’t pay too much attention to is the level of volatility occurring in the stock market. It is obvious that stock prices move around, but there are times that the movement is more significant versus other times.
There is actually a strong relationship between how the stock market is doing and how volatile it is. During periods of relative calm the stock market tends to do better.
Currently market volatility is quite low. It is actually near its lowest level of recent years. Not surprisingly, the market has been performing well in recent weeks, and has established new all time highs.
This relatively low volatility might come as a surprise to many investors, considering all the things happening in the world. What investors need to remember is that there are always some events occurring both in our country and the rest of the world.
Looking at the rest of the world, the most recent significant event had been the vote in Britain to leave the European Union. When that measure was approved, market volatility increased, and stock prices fell. However, when the realization became that this process would take a number of years, and the impact on the U.S. economy would likely be slight, volatility fell.
The other major factor impacting market volatility is the perception of the U.S. economy. There have been times in recent months when there were significant concerns that our economy was weakening. However, those fears have not materialized and volatility has subsided.
There is one thing that is quite unusual about this current period of low market volatility, and that is the direction of interest rates. When market volatility is high, there tends to be a flight to quality, and U.S. Treasury yields fall. When volatility is low the demand for safe assets would normally tend to fall, and you would expect interest rates to rise.
While interest rates have moved a little higher from their recent lows, they are still at extremely low levels, when looking from a historical perspective. Extremely low and even negative interest rates throughout the world are having an influence on keeping our rates low. While our yields are very low from a U.S. perspective, for foreign investors 1.5% for a 10 year U.S. Treasury is certainly better than 0 for their government bonds.
The major uncertainty for investors would be whether this current period of low volatility will continue. Unfortunately, there is no easy answer to that question.
Looking at a chart of market volatility in recent years, someone would notice that it has stayed relatively low most of the time, but periodically it will spike upwards. Over the course of a normal year there will likely be several times when volatility does tend to spike because of an unexpected event occurring.
Based on the expectation that volatility is likely to increase again in the not too distant future, that might imply this would be an opportune time to sell. If someone has a larger than normal position in stocks, that would be an appropriate move.
However, if someone is just trying to time the market that strategy could easily fail. The issue is that the next increase in volatility causing the market to decline might be two weeks away, or it could be six months. Also, when it does occur prices might only drop a fairly insignificant amount.
What investors need to realize is that there is nothing permanent in the stock market. That is when there is a period low volatility like we currently have, someone shouldn’t expect that to continue indefinitely. Likewise, when the market is performing poorly and volatility is high eventually things will improve.
It is important for investors to not become too optimistic when things are going well and the market is calm. Likewise, regarding bad markets during high volatility, investors should not panic and exit the market. Keeping a balanced longterm perspective on the market should help someone’s long term returns.
