As noted in this CNBC article, The CBOE Volatility Index (VIX) which is widely interpreted to be an indicator of fear has risen by 40% (actually 57% based on the 12/10/2014 close) over the three trading days ending 12/10/2014. VIX measures the market’s expected short-term future volatility of the S&P 500 Index, and it usually increases when the market has shown higher-than-normal volatility, particularly in a downward direction. For the three day period previously mentioned, the S&P 500 Index has declined all three days for a total of 2.4%. Some observers have connected the decline to the decrease in oil prices which are a tailwind for the overall economy but a tough pill for energy companies. The Energy Select Sector SPDR ETF is down 6.0% for the three-day period.
Obviously, we at Index Fund Advisors pay little attention to short-term market movements. If, indeed, we are going to have higher volatility going forward, then we can say (jokingly) that maybe it was overdue since volatility (as measured by annualized standard deviation) has been unusually low for the past few years compared to long-term historical levels, as shown in the bar chart below:
Of course, the 86-year period includes the Great Depression and World War II, the likes of which we hopefully will never see again.
Any traders who were long on VIX made a killing at the expense of those unfortunate souls who were short. We don’t read anything much into it beyond that. Occasionally, we have been asked if a VIX exposure is a good diversifier to a U.S. equity position, and the recent opposite movements of both would appear to support this idea. It is important to remember that VIX is nothing more a bet on the future direction of volatility. Like other futures, it has no intrinsic value or expected return, so we do not consider it to be a recommended part of a diversified portfolio.
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About the Authors
Mark Hebner and additional IFA employees contributed to this article
Founder and President of Index Fund Advisors, Inc., and author of Index Funds: The 12-Step Recovery Program for Active Investors. He is a Wealth Advisor, with an MBA from the University of California at Irvine and a BS in Pharmacy from the University of New Mexico with a specialization in Nuclear Pharmacy.