Calibrate Wealth January Newsletter
by Zach Marsh on Feb 1, 2018
January Monthly Review
Recap of Asset Price Performance
|Jan Return||Jan Return|
|S&P 500||5.60%||30 Year Treasury||-3.26%|
|Russell 2000||2.60%||10 Year Treasury||-2.18%|
|EAFE (Developed Markets International)||5.00%||Corporate Bonds||-1.12%|
|EEM (Emerging Markets)||8.20%||Gold||3.26%|
|CBOE SMILE Index||4.50%||TIPs||-0.80%|
January 2018 Monthly Newsletter
Well, 2018 has sure started with a bang. The broad market index, S&P 500, is off to its best start since 1997. This remarkable month has follows on the heels of a very strong 2017 in which the S&P 500 was up 21.6%. The entire year last year was marked by steady and consistent monthly gains, with volatility plunging to lower and lower all-time records. So, what can this month’s gains tell us? What information are we to glean from this dramatic leg up in the market. Well, one thing it may tell us is that the era of low volatility could be coming to an end. A fairly unique thing happened on more than one occasion this month: we witnessed numerous days in which the CBOE VIX Index, commonly referred to as the fear index for its tendency to move higher when the stock market moves lower, was actually up when the stock market was up. While trying to interpret meaning from the option market can be fraught with many challenges, this correlation could be seen as an indication that many market participants are buying call options to chase the market as it moves higher. It is also an indication that the magnitude of the stock market up days justifies higher option premiums than were previously priced in the market. Additionally, it is also prudent wisdom that volatile moves up lead to even more volatile market retracements. In the late 90’s we saw this type of behavior frequently, as the market started shooting higher, notable names in the technology sector like Amazon, Qualcomm, and Yahoo seemed to have their volatility rise in synchrony with their stock price. But this probably begs the question, does higher volatility mean lower returns, and should we view this year’s similar start with the ominous 1987 start?
Like some participant in a sadistic Pavlovian experiment we all seem to be waiting for the next shoe to drop, or better yet, axe to fall. As the market explodes higher and higher we seem to become more certain the end of days is nigh. But is it? Certainly, our experiences from the last 18 years or so has shown us that all good things eventually come to an end, and that at precisely the moment we are feeling most confident, the floor is about to collapse. But is this real or is it just some form of PTSD? And, does the market give us any hints as to when the bubble is about to pop?
First let’s begin by saying that rising market volatility does not systematically mean that the market is about to crash. One thing that it does mean is that market returns will become choppier. Last year the S&P Total Return Index did not have one single down month, nor did it, conversely, have a month with returns higher than 4%. This type of low volatility, steadily climbing market was similar to the market environment in 1995. In 1995, volatility was slightly higher than last year, averaging 12.4% vs 11.05%, but so were the returns (37.2% vs 21.6%). While returns continued grinding higher all year in 1996, the pace of the returns quickened. Market volatility in 1996 began to increase and by the end of the year the CBOE VIX Index stood at 20.9%. In 1997, the CBOE VIX averaged 23.26% for the year, in 1998 it averaged 26.25%, and in 1999 it averaged 24.54%. The VIX index didn’t return to its 1995 level again until 2006. The climbing VIX index, however, didn’t portend the end of the bull market in 1996. In fact, from 1996-1999 the S&P 500 continued to race higher, with compounded returns over those years eclipsing 150%. As we know, that bubble eventually popped and the subsequent market collapse between 2000-2002 was a painful experience for a great many investors, but the pain of abandoning the market between those years would’ve been painful as well.
So, at this stage you may be saying, “Well it’s different this time, this time the we are deep into a long bull market cycle that began back in 2009.” But is it so different than it was in January 1996? By January of 1996 the S&P 500 had enjoyed 5 consecutive years of positive returns, and 13 of the previous 14 years had been positive (only 1990 was down and that was only by -3%). Hardly the sign of a bull market in the infant stages. In fact, the increasing pace of returns is generally a sign of the first year of a bull market and the last stages of one as well.
But, I want to caution you. I’m not here trying to contend that we are in the beginning stages of a late 90’s market redux. As I mentioned earlier, the CBOE VIX index returned to those lower volatility 1995 levels again in 2005. Now again, 2005 was not the top of the market. Returns in 2006 were a solid 15.6% for the S&P 500. However, it certainly didn’t afford us another 4 years of exceptional returns. That time it was only another year and a half before the music began to stop; and stop it did in an epic fashion.
So, if the returns of the past month are to teach us anything it might be that volatility could be a lingering and persistent fact of life for the next few years, but it might be awhile before the increase in volatility leads to the end of the bull market. Bull markets don’t typically stop and turn on a dime and nosedive downward. To borrow an analogy from an old Seinfeld episode, pushing over the stock market is like pushing over a soda machine, it takes a lot of rocking back and forth before it falls. Volatility is the rocking that begins the process. How long that lasts remains in question. What you may have to become more accustomed to is a bumpier ride.
One thing to remember, though, is that the stock market is only a part of your investment portfolio. We, at Calibrate, believe in building portfolios that are balanced according to the volatility each asset adds to the portfolio. This is why we are so focused on the nature of volatility. We believe that volatility is the essence of all asset acquisition. When we buy assets, we acquire the volatility of that asset, that is our input, the return is only the anticipated output. By balancing you input we strive to build a safer portfolio allocation that will help you better weather all types of market climates.
Thank you for reading and thank you for your patronage. We are excited about the new beginnings here and appreciate your support.
Zach and David