February 3, 2015 - Should We Tighten Our Seatbelts? 

Beginning last October, certain sectors of the US stock market have experienced a series of relatively volatile periods. But to listen to talking heads on the 24-hour news channels, one would think that the entire market is going crazy and that we have never seen this type of volatility before. Both of these assertions are untrue.

Investopedia® defines volatility as “A statistical measure of the dispersion of returns for a given security or 

The most popular volatility measure that most people cite is the CBOE’s S&P 500 Volatility Index or “VIX”. The VIX, as its name implies, measures in real time, the price movement of the S&P 500 index. Watching the VIX therefore gives one a good view of how this group of large U.S. stocks is behaving at any point in time. But to watch it out of context, like the news media seems to do, may not be the best way to reflect on your own situation or the risk associated with your own investment portfolio. To look at the VIX in the context of the overall U.S. market as well as from a historical perspective may provide a more relevant picture. movements, up or down, the greater the volatility. Price volatility is also used as a measure of an asset’s risk.market index.” Simply stated, volatility is the amount of day to day price fluctuations of a stock, a bond or an index. The larger the daily price

MarketCommentary_2015_Q1 Chart.jpg

The graph at the right shows the movement over the past six months of VIX along with another CBOE index, RVX, which measures the volatility of the Russell 2000 index, an index comprised of 2,000 small cap U.S. stocks. In both cases, a higher point on the graph indicates a higher level of volatility of the underlying index. You can clearly see that, while both jump around a bit, the S&P 500 has been a much riskier asset class to own over the past six months than the Russell 2000. This is a little counterintuitive since small stocks are supposed to be riskier than large stocks. This is true over the long term, but six months is not the long term; nor is 3 months. Unfortunately one quarter is the length of time over which many people tend to judge the success or failure of an investment strategy. This graph also illustrates the key reason we diversify clients across many asset classes. An interesting fact not reflected in this graph is that over this six month period the total return of Russell 2000 was more than twice that of the S&P 500 – also a good reason to be diversified.

You can see in this graph that the level of volatility for both indices has been steadily decreasing over the past six months. Again, six months is not a long time from an investment time horizon point of view but I mention this so that you will be aware when you hear the media suggest that the markets are very volatile, that many asset classes are actually less volatile than they have been in the recent past. A longer term view provides even a better perspective of today’s market volatility. The graph below shows VIX and RVX during some truly volatile periods. Given what we lived through in 2008, 2010 and 2011 current volatility levels look much less threatening.

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