Inside Volatility Trading: Market Truisms

Kevin Davitt
October 6, 2020

And I rose

In rainy autumn

And walked abroad in a shower of all my days.

High tide and the heron dived when I took the road

    Over the border

      And the gates

Of the town closed as the town awoke.

  A springful of larks in a rolling

Cloud and the roadside bushes brimming with whistling

  Blackbirds and the sun of October

Dylan Thomas

If 2020 was a marathon, U.S. readers are approaching mile 20. For our global audience, we just passed the 31.6-kilometer mark and have 10 and ½ km to go. Relative to a more “normal” year, 2020 has a bit of an ultramarathon feel.

There’s an innate human tendency to segment periods for the sake of comparison. Mother Nature cycles through the seasons. Humans do likewise: infancy, childhood, adolescence, early adulthood, middle aged, etc. In a similar vein, market participants often slice time as a means of measurement and benchmarking.

To paraphrase a couple of market truisms:

  • If you can’t measure it, you can’t improve it… and
  • It’s hard to measure almost, because almost doesn’t matter.

Over the past decade, on average, Q3 has been the most difficult period for the S&P 500® Index. Overall Q3 performance was hampered by the 14.33% decline for the period ending September 30, 2011. As we referenced in the previous Inside Volatility, 2011 was arguably the last time the broad market experienced persistently elevated levels of volatility. 

The fourth quarter has been, on average, the strongest three-month period for the S&P 500 over the same time horizon. The average quarterly gain is 3.87%. The final three months of last year were stellar with the Index adding 8.53%. However, there was no Santa Claus Rally in 2018 as the market fell by nearly 14%. 

Source: Morningstar & Cboe Global Markets

It’s been said countless times, but bears repeating, 2020 has been an unusual year. Front and center is the coronavirus pandemic which has infected 7.2 million and killed 205k in the U.SGlobally, nearly 34 million have fallen ill and over a million have passed away. Beyond that there have been horrible brushfires, the postponement of the Olympicsmurder hornets, and Elon Musk and Grimes named a child X AE A-12. Good luck on your standardized tests young man.

With respect to equity markets, the largest quarterly decline and advances of the past decade occurred this year. The Cboe Volatility® Index (the VIX® Index) had its highest ever close (82.69) on March 16, 2020. The average closing level for the VIX Index is 30.50 – the highest since 2009. Furthermore, the ‘vol-of-vol’ as measured by VVIX℠ had its longest stretch ever (closing) over 100, which just ended (9/25). The last VVIX close below the 100 level was February 20 (one day after previous all-time highs for S&P 500).

Source: LiveVol Pro

Here’s a relatively short (10 page) white paper on Cboe’s VVIX Index. The Index applies the VIX methodology, but instead of SPX® Index options as the inputs, it uses VIX option values. VVIX is a dynamic measurement of the expected volatility for the VIX Index. It could be used to calculate the mean and standard distribution of settlement values for VIX futures and options. Another way to look at the Index is as a relative barometer for the cost of shorter-dated (1-month) VIX options.

Like the VIX Index itself, VVIX is not tradeable, but it can be used to inform decisions for those interested in volatility markets. At the beginning of October, VIX options (1-month maturity) are cheaper on an implied volatility basis than they have been in months.

At the moment, it seems like the ~10% pullback in the S&P 500 from the September 2 highs (3580) to the September 23 closing low (3237) was a “healthy correction.” That could certainly change if sentiment turns, but as we move into Q4 the broad market seems to be relatively well-balanced.

Interestingly, the previous four drawdowns of at least 10% in the S&P 500 were consummated days before the end of quarter. Late March (Q1) and late December (Q4) of 2018. This year, the S&P 500 rebounded on March and September 23, just before the end of the first and third quarters. The March 2020 decline was 34% and the December 2018 selloff was 19.8%. The other two were much shallower.

Source: Bloomberg

So, what’s it all mean for this year? October has a history of significant S&P selloffs. Since 1951, August has the highest median and average peak to trough drawdown in the S&P 500 (2.2% median and average of 3.2%). October has the second highest median and average drawdown over the same period at 1.9% and 3.1%, respectively.

For students of market history, the Panic of 1907 reached its nadir in October. In the tenth month of 1929 there was a “Black Monday, Tuesday, AND a Black Thursday.” Yikes. The worst single-day decline in market history occurred on Monday, October 19, 1987. In October of 2008, the S&P 500 dropped 16.9% and the VIX Index measured 89.53 intraday on October 24.

This is also an election year. Looking at every presidential election since 1992 (Bush v. Clinton), the average October return for the S&P 500 shows a decline of 2.45%. If you eliminate October of 2008, the average is fractionally negative (0.03%).

More contemporaneously, in October of 2016 the S&P 500 fell 1.94%. In the month before the 2012 election the broad market lost 1.98%.

While this year has been anything but average, let’s look at some historical averages for perspective. The average close for the VIX Index with nine months in the books is 30.5. If that average holds, it would be the highest annual measure since 2009 (31.48) and 2008 (32.69). The average of these annual averages is 19.51. This paragraph averaged 1.2 “averages” per sentence. 

Source: Cboe Global Markets

Much has been made of the potential for macro volatility tied to the upcoming election. We’ve cited examples in every recent Inside Volatility. Both buy- and sell-side participants have alluded to the steepening of the October/November VIX futures spread. Perceived volatility risk has been moving out in time as evidenced by the outperformance of November VIX futures relative to October for most of the past month.

Source: Cboe Global Markets 

October VIX futures will expire on 10/21 based on the 11/20 SPX options. The November VIX futures will expire on 11/18 based on the 12/18 SPX options. Market and political pundits point to a provision in an 1887 act of Congress called The Electoral Count Act, specifically the Safe Harbor clause. According to The New Yorker:

“it provides that, if a state submits its final tally in the Presidential contest by six days before the meeting of the Electoral College, that decision is ‘conclusive’ and thus free from legal challenge. This year, the safe-harbor deadline is December 8th; the Electoral College meets in each state capitol on December 14th.”

So, as we move into the last leg of the marathon that is 2020 – uncertainty abounds. The paramount concern seems to center on the election and the prospect of a contested outcome. Beyond that there’s division over the prospect of further fiscal stimulus from a fractured Congress. There are questions about the appointment of Justice Amy Coney Barrett to the high court. The prospect and timing of an effective COVID-19 vaccine and overall valuation concerns also resonate.

Some analysts point to the prospect of Democrats controlling the White House and Congress as a return to “higher taxes.” Mandy Xu of Credit Suisse argues otherwise, calling attention to the prospect of large fiscal stimulus from a unified Democratic government.

Here’s a look at the growth rate of GDP/Capita under recent administrations. The Trump data is derived from prior to the COVID-19 pandemic.

Source: Bureau of Economic Analysis and the New York Times

That “wall of worry” may be formidable, but despite it all the S&P 500 is up about 4.4% year-to-date. The Nasdaq 100 is higher by more than 31%. The DJIA is off by 2.25% and small-cap Russell 2000 has declined by 9.31%. We’ll see what the final quarter brings!

Well the summertime has gone

And the leaves are gently turnin’

Van Morrison – Purple Heather





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