Normal Markets: Are We There Yet?

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Normal Markets: Are We There Yet?

When will things get back to normal? That will likely end up being 2021’s most asked question pretty much everywhere on planet Earth. Sitting in midtown Manhattan as I write this note, normal feels very far away indeed. The streets are for the most part empty, even though most of the residential buildings in my neighborhood are brightly lit at night. Car traffic on 57th Street (midtown’s major thoroughfare) is only heavy from 7 – 9 am and 4-6 pm. After about 10pm, you could roll a bowling ball from my apartment to the Tiffany store on Fifth Avenue (about half a mile down the road) with little risk of hitting anything or anyone.

Exactly what constitutes “normal” when it comes to US equity market action is certainly harder to pinpoint than what that word means in terms of city life. The S&P 500 is up 16% over the last 12 months, which is hardly unusual, but how it delivered that result is certainly not normal. The index is up 72 percent from its March 2020 lows, after all.

I’ve often thought that what US equity investors consider “normal markets” are really periods of time when both actual and implied volatility are below statistical averages. Consider:

  • The long run mean of the CBOE VIX Index back to 1990 is 19.5. The standard deviation of that average is 8.1. Statistically, therefore, anything from a VIX of 11.4 to 27.6 is in the meaty part of the bell curve and “normal” (stat-nerd pun… sorry).
  • But … think back across your investing career and identify periods you consider normal. They’re more likely to be spans of time like 2004 – 2007 or 2012 – 2017, or even 1992 – 1996 if your gray hair count matches mine.
  • All those periods rarely saw the VIX cross the 20 line to the upside.

That got me to thinking: what’s the average amount of time it takes the VIX to go from event-driven peak (and its almost always a specific event that jacks it higher) to below 19.5 (i.e., “normal)?

Here’s the data:

  • 1990 – 1991: 122 trading days
    The Iraq invasion of Kuwait on August 1st, 1990 took the VIX to 36.5 on August 23rd and the Coalition military response early in 1991 saw the VIX get to 36.2. It first broke 20 on the downside February 15th,1991.
  • 1997 – 1998: 76 trading days
    The Asia Crisis did not have a lasting effect on US stocks, but in October 1997 the VIX did get to 38.2 and took until February 1998 to decline back to 19.5.
  • 1998 – 1999: 184 trading days, or 35 days depending on how you count
    The collapse of Long Term Capital Management started in September 1998 and by October 8th the VIX was at 45.7. It did get down to 22.1 by Thanksgiving, but the volatility around the final stages of the dot com bubble in 1999 meant the VIX didn’t actually drop below 19.5 until July 1999.
  • 2001 – 2002: 119 trading days
    The VIX peaked on September 20th, 2001 at 43.7 after the 9-11 terror attacks and did not get below 19.5 until mid-March 2002.
  • 2002 – 2003: 193 trading days
    Mid-2002 was a hot mess of news related to both the unwinding of the dot com bubble as well as concerns over mounting geopolitical risk regarding Iraq. The VIX peaked at 45.1 on August 5th, 2002 and would finally close at 19.5 almost a calendar year later, on May 12th, 2003.
  • 2008 – 2009: 273 days
    Before 2020, the all-time high close on the VIX was 80.86 on November 20th, 2008 in the depths of the Financial Crisis. It finally closed at 19.5 on December 22, 2009.

Now, it’s been 214 trading days since the VIX’s record close of 82.7 on March 16th, 2020 and we haven’t had a 19.5 level close since, so the clock is still ticking on when we might get back to “normal”. The historical comps above show us that the Pandemic Recession has made for the long “unusual” stretch of market volatility pricing since the Financial Crisis.

If we use the post-Financial Crisis period as our template, “normal” should arrive in another 59 trading days. That puts us at March 31st, 2021 if I’ve counted correctly, or just about 1 calendar year since things became distinctly not-normal.

I’ll close out with a thought that’s probably occurred to you if you’ve ever traded options: stock returns from “peak VIX” back down to “normal” are usually excellent, but past that there’s less assurance of further gains unless the VIX declines even more. Seeing the VIX get to 19.5 in March seems reasonable. But can it go to 16-17 by December 2021? While that seems unlikely based on everything we know today, positive stock returns will come more easily if we do see that sort of VIX action as a “normal” 2021 develops.