What could short-term volatility mean for long-term investors?

Mar 13th, 2020 | By | Category: Equities

By Nick Kalivas, Senior Equity ETF Strategist at Invesco.

Nick Kalivas, Senior Equity Product Strategist at Invesco.

Nick Kalivas, Senior Equity Product Strategist at Invesco.

Markets are continuing to be highly volatile, and the past two weeks have seen historic gains and losses. While I prefer to evaluate performance over longer periods, it’s understandable that investors are especially interested in the market’s daily fluctuations. Here’s what I’ll be watching in the coming week and months.

On 28 February, the CBOE Volatility Index (VIX) — which measures expectations of near-term volatility — closed at 40.11. This is unusual, as there have only been seven periods since 1990 that saw the VIX finish the week over 35, but it’s hardly surprising given the recent volatility we’ve seen.

Interestingly, though, history shows that a weekly close in the VIX above 35 is correlated with higher stock prices in the next year. One year after each of the seven periods where the VIX closed over 35, the S&P 500 Equal Weight Index was higher, with an average return of 15.5%.

In contrast, the average VIX return was -38.4%. What’s more, over the same period, the S&P 500 Equal Weight Index outpaced the S&P 500 by 0.4%. (The one exception was the aftermath of 11 September and the headwind created by the “popping” of the technology bubble.)

So, what does this mean for investors? In my view, the VIX reflects investors’ current state of unease, but it also represents a buying opportunity for investors willing to take a longer-term approach.

RELATED ETFs

Invesco S&P 500 Equal Weight ETF (RSP US)

  • Tracks the S&P 500 Equal Weight Index,
    providing exposure to S&P 500
    constituents which are equally weighted
    on a quarterly basis.
  • Comes with an expense ratio of 0.20%;
    houses $11.5 billion in AUM.

Invesco S&P 500 Low Volatility ETF (SPLV US)

  • Tracks the S&P 500 Low Volatility Index,
    providing exposure to 100 S&P 500
    constituents with the lowest realized volatility
    over the past 12 months. Constituents are
    weighted by the inverse of their volatility.
  • Comes with an expense ratio of 0.25%;
    houses $10.0 billion in AUM.

Equity volatility may linger

The US market is in for a volatile year. Recent news reports suggest the worst of the coronavirus has yet to impact the US, and the market will be vulnerable to pricing the policy risk in the lead-up to the November presidential election. The country is very polarized, so I believe there is a risk that President Donald Trump’s generally friendly fiscal/regulatory policies could be reversed. I believe the political dynamic is a reason for investors to consider holding onto low-volatility stocks.

Tracking the impact of the coronavirus

When it comes to monitoring the impact of the coronavirus on economic activity, I recommend watching the price of oil and the direction of industrial commodity prices. Energy is critical to transportation and production, and it is likely to produce less noise than government comments and the talking heads in the media.

Moreover, the Atlanta Federal Reserve’s (Fed) GDPNOW forecast for Q1 growth is 2.7%, durable good orders looked to be on the upswing (helped by the inventory cycle), and pending home sales appeared to be especially strong. Moreover, the Philadelphia Fed non-manufacturing survey was stout, pointing to robust growth. The strength of economic growth going into the shock of the coronavirus may reduce the severity of its impact on the market.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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