Is 1Q18 Volatile?
Is 1Q18 equity market volatile? It surely feels so. According to the chart, there were 23 days during 1Q18 in which the S&P 500 Index (SPX) moved more than 1% in either direction, compared to two days in 1Q17 and eight days in all of 2017. We have also experienced two days of more than 3% movement, which has not happened since 2010. On the morning of February 6, CBOE Volatility Index (VIX) touched 50. Several drivers contributed to the more volatile market:
- No more cheap money, due to rising interest rates and normalizing the Fed balance sheet. It was the February wage data that exacerbated these concerns and fused the equity selloff.
- Looming U.S.-China trade war tension.
- Sector correlations bounce back.
- Another $250B in assets flowed into passively managed strategies in 2017. I believe this not only increased the sector correlations, but also thinned market liquidity.
- Last but not least, the VelocityShares Daily Inverse XIV Short-Term exchange-traded note (XIV) was liquidated. It had over $2B in volatility selling.
Does 1Q18 still feel volatile if 2017 had not happened? 1Q16 had more 1% movement days than 1Q18. From 2000 to 2017, there were six years during which 1Q had more 1% movement days than 1Q18. On average, first quarters since 2000 have had 18 1% movement days. All these make me think that the real tail event was the year of 2017, just on the lower end of the spectrum. 1Q18 was more volatile than average, but far from the worst. The 50 print of VIX was more because of liquidity than equity selloff. Also interesting is that 1Q00 and 1Q18 are the only two first quarters when the realized volatility was higher than the average VIX. This may suggest a current tendency of relatively underpricing the volatility.
Coming off the unusually quiet 2017, 1Q18 felt more dramatic than it actually was. As people expect to have strong economy and earnings growth but worry about high equity valuation, rising interest rates and political uncertainties, it seems the volatility is here to stay. The financial environment will be more costly and challenging for risk management. We might have many quarters like 1Q18 down the road, while the chance of repeating 2017 is much lower.
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