Rising Volatility In the Fall

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Rising Volatility In the Fall

“It sure is quiet out there… too quiet.” That’s the Airplane! quote we used to start off a piece on volatility at the end of July, when we warned US equity market volatility was about to ramp a lot higher. August proved that was the case, and we continue to warn that this kind of heightened market churn will extend through October.

By way of background, we measure volatility based on how many days the S&P 500 rises or falls by 1% or more in a given trading session. Here’s a breakdown of how quiet this year was through the first half and July:

  • There were only 11 days when the S&P had a daily return of +/- 1% in the first quarter, compared to Q1’s average of 13 since 1958 (first full year of data). Three of those 1% days were negative, while the balance were positive.
  • There were only 7 one percent days in the second quarter (4 down, 3 up), versus Q2’s average of 13 over the last six decades.
  • The quarterly average for Q3 is also 13, but there was only one 1% day in July. And it wasn’t until the last day of the month, when the S&P fell 1.09% on July 31st.

Here’s how things shaped up in August and Q3 thus far:

  • In August alone, there were 11 one percent days, or as many as there were in the entire first quarter of 2019. There were 4 down 1%-or-more days and 7 up 1%-or-more days.
  • There have also already been two 1% days in September over the past two trading sessions.
  • That brings the total tally of 1% days to 14 in Q3, already surpassing the quarterly average of 13 by one with still 17 trading days left in the quarter.

As for the year overall, a few points:

  • There have been a total of 32 one percent days so far this year compared to the annual average of 53 over the past 60 years. If there were normal market churn, there would be about one 1% day a week, but as we showed the market was unusually calm this year through July.
  • Our bar chart of annual S&P 1% days after this section shows a clear pattern over the last six decades. Large market swings happen during the beginning of a bull market, abate and then climb again towards the end of annual sequential gains in US stocks.
  • This last cycle has been more mixed than usual. The post-Great Recession low will likely be 8 one percent days in 2017. Last year was more in keeping with late cycle norms at 64 one percent days versus the annual average of 53, but this year is running below pace at 32.

The number of 1% days this year could get back to the annual average, however, as we think September and October could be just as volatile as August. Here’s why:

  • Another way we track volatility is by counting how many times the VIX has peaked or troughed during each month of the year since it was created in 1990. By this measure we were not surprised equity market volatility was muted in July, as the VIX has bottomed the second most number of times at 6 during this month (December is most commonly “trough VIX”).
  • Conversely, seasonal trends showed volatility would ramp higher in August as we cautioned at the end of July. The VIX has peaked 5 times in August, one of two months tied for the most number of highs for the year. October is arguably even more volatile with the VIX having peaked 5 times during this month, while never bottoming. September could also be choppy, as the VIX has peaked twice and never troughed during that month.
  • The good news: markets typically quiet down in November and December. While the VIX has reached its high for the year twice in November, it has also bottomed three times during that month. The VIX has hit its high for the year in December once, but has troughed eight times which is the most of any month.

The upshot: seasonal volatility trends predicted higher market churn in August, and they are pointing to more of the same this month and next. This trend fits with our “Strong January playbook” as we outlined in Tuesday’s report, when returns are usually lower August through October during years when January has an outsized positive return. We also think the current climate fits this narrative as investors game future Fed action, expectations for corporate earnings and the ongoing US-China trade war. The market should find some support in November and December, however, and still end the year higher.