The Tell: Stock market may look calm lately, but volatility remains a threat in 2018

Declining volatility, at least as measured by one popular index, since the start of April has given stock-market investors a bit more confidence, but don’t get used to the calm just yet, says Jessica Rabe, co-founder of DataTrek Research.

Both implied, or expected, volatility and realized, or actual, volatility in U.S. equity market has fallen in the second quarter after a February spike that sent ripples through financial markets. But history suggests that once volatility spikes, it has a staying power.

The most often cited measure of volatility, the Cboe Volatility Index VIX, +0.07% or VIX, has recently fallen to its lowest levels since January, trading at around 13. The VIX, which is calculated based on options action in S&P 500 stocks and represents expectations for volatility over the coming 30-day period, peaked at 37.3 on Feb. 5, when it rose 100% in one day, mostly due to a meltdown in exchange-traded funds that allowed investors to bet volatility would remain subdued.

But there are other ways to look at volatility. Rabe also took note of the number of days the S&P 500 moved up or down by more than 1%. Rabe noted that so far this year, the S&P has gained or lost more than 1% on 32 days, compared with the annual average of 53 since 1958.

Read: Wall Street’s ‘fear index’ is giving stock-market investors a wrong reading, says Goldman

While the frequency of 1% days has declined after a torrid first quarter, there have been 9 such days in the second quarter (there were 23 in the first quarter). But with more than 30 sessions left in the quarter, the market could easily hit the long-run average of 13 days with 1% moves, she said. Also, historical data shows that in years when the S&P saw between 20 and 25 1% days in the first quarter, there 19 such moves in the second quarter.

Jessica Rabe, DataTrek

In fact, it’s likely that the peak in volatility for 2018 lies ahead.

It isn’t surprising that volatility calmed in May, with data showing the VIX has only peaked once in May, she said. Next month could be more volatile, with VIX hitting its annual high three times in June.

And it’s the second half of the year that has the most volatile months, particularly August and October. Since 1990, VIX has hit its annual peak five times in each of those months.

Volatility doesn’t necessarily mean negative returns, noted Rabe. In heavy volatility years, the S&P returned 1.9% for second quarter despite the gyrations.

The S&P 500 SPX, +0.02%  is up 3% so far this quarter, trading at 2,724.24 on Thursday.

Read: An indicator that is ‘90% accurate’ suggests hidden strength in the stock market

The main takeaway is that if you thought February volatility was rough, it is likely only to get worse in the second half of the year, she said, adding that’s not necessarily such a daunting prospect.

While seeing fluctuations in portfolios is painful, another downside move could offer a welcome entry point for long-term investors, Rabe said.

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