Hi, I’m Jack Leslie, Portfolio Manager at Miller/Howard Investments. Lately, our clients have been asking us what we think about the recent increase in stock market volatility.
Professional investors often measure volatility using the Chicago Board Options Exchange [SPX] Volatility Index, or the VIX for short. If you look at a recent chart of the VIX, you can see that after about a year and a half of relative stability, the Index spiked up in February . The blue line shows the Index level at the end of the second quarter. Even though volatility is now down from that spike, it is still above where it had been before. This increased volatility might seem unsettling, and perhaps even ominous, but if you take a longer-term view and look at the average of this volatility measure since its inception, shown here by the dark red line, you see a different picture. Now, you can see that even though volatility is higher than it has been most recently, it is still below its long-term average.
In fact, if we look at a chart since the VIX’s inception, we can see that volatility has been pretty tame over the last few years. When looked at in this longer context, we can see that this recent spike only seems more unsettling because the market volatility had been much lower than average lately.
Even the timing of the recent spike is far from exceptional. Volatility has spiked this high at least nine times since the start of the Index over 28 years ago, sometimes much higher, and often it has remained higher for longer. This means that, on average, we see one of these spikes every three or so years, and coincidently the previous one was just about three years ago. The stock market doesn’t follow a timetable of course, but the timing on the most recent spike is pretty unremarkable.
Now, if knowing that recent volatility is below average and well within the range of what’s to be expected still doesn’t make you feel any better, perhaps you could find a stock market strategy that will let you sleep better at night.
Let’s look at the components of volatility. Professor Roger Ibbotson has researched US asset price movements back to 1926. Using his data, we can see that since 1990, the Ibbotson® Large Company Stocks Index has annually returned somewhere around ±37%. That is a pretty wide range. But his data also lets us break down these total returns into their two components: price return and income. Here we can see that stock prices are what drive this volatility.
Looking at his price only return data, we see that large company stock prices have swung anywhere between up +34% and down -38% during this time period. That’s a lot of price variance. In fact, price volatility accounts for almost all of the stock market’s volatility. It’s prices, driven by investors’ fear and greed, that drive the ups and downs of these large company stock returns.
When we look at just the income component of total return, shown here on the same scale as the last two charts, we see that the income returns aren’t volatile. Income, or dividend yields, have added between 1.1% and 3.8% to shareholder wealth every year, without the peaks and valleys seen in stock prices.
Another feature of the income portion of total returns is that it is always positive. Sometimes a bit more, sometimes a bit less, but always positive — always adding to the investor’s wealth. Always pushing total returns higher.
If stock market investors can focus their investment strategy more on more stable dividend income rather than on more volatile price return, they should expect less volatility in their portfolio. For some investors that could mean a better night’s sleep while still staying fully invested in the stock market.
Definitions and Disclosure
Source: Thompson Reuters; Source: 2018 SBBI Yearbook
Chicago Board Options Exchange Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market's expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange (CBOE).
Ibbotson® Large Company Stocks Index is represented by the S&P 500 Composite Index (S&P 500) from 1957 to present, and the S&P 90 from1926 to 1956.