Yeah, so picking up mid-stride where we left off this morning on how anyone buying equities at this point has, to quote SocGen, “a problem,” we would note that there’s one saving grace.
That is, while buying at ridiculous multiples dooms your excess returns (i.e. returns above risk-free Treasurys), it doesn’t necessarily mean you’ll wake up tomorrow to a massive drawdown that will wipe out half your investment.
See the thing is, you can buy at valuations that are in the 80-100th percentile versus history as long as volatility remains passed out drunk on the couch. Don’t believe us? Just look:
See there? Everything will be fine as long as vol stays glued to the proverbial flatline.
Seen in that light, it’s no wonder buying equities worked in Q1, because as Goldman notes, we just witnessed the calmest first quarter in terms of average VIX level of all time.
Lowest Q1 VIX level on record
- Despite a quarter characterized by elevated policy uncertainty and an intense focus on tax reform, infrastructure spending and deregulation, U.S. equities had one of their lowest volatility quarters on record.
- The average VIX level in Q1 was 11.69, the lowest first quarter in VIX history. Low volatility levels were persistent, with the VIX trading in a tight band between 10.6 and 13.1 over the first quarter.
- If we include all calendar quarters, Q1 2017 was the second lowest quarterly average VIX level back to 1990; only ranking behind Q4 2006, when VIX averaged 11.03.
S&P 500 realized volatility: lowest Q1 in five decades
- Was the low Q1 VIX justified? Judging by SPX realized volatility the low Q1 VIX was not that surprising. The VIX is a market based expectation for S&P 500 realized volatility and when the market isn’t moving the VIX will reflect that by dropping to the low end of its historical range. And the market really wasn’t that volatile in Q1.
- While the VIX has only been around since 1990, we can use S&P 500 realized volatility to provide broader context. S&P 500 calendar quarter realized volatility was 6.69, the 4th lowest Q1 since 1929 and lowest Q1 since 1965. S&P 500 realized volatility over the first quarter of 2017 ranked in the fourth percentile across all quarters back to 1929.
Low VIX does not suggest an impending market decline
- In our “VIX as a market timing signal” report we showed that contrary to popular belief, a low VIX has not historically signaled an impending market decline. After a VIX decline below 11, median VIX levels over the next week, month and quarter were all fairly low at 11.1, 11.4 and 12.1, respectively. This quarter followed that script perfectly, averaging 11.7.
- Economic data also points to a low VIX: Estimating the VIX based upon payrolls, ISM levels and economic policy uncertainty suggests an average VIX level of 13.7, two points higher than the Q1 average.