Volatility in the first quarter of 2012 reached a new post-2008 crash low, diving 73% quarter-over-quarter. For the 1Q12, the average daily change in the value of the S&P 500 index was ±0.35%, compared with ±1.30% in 4Q11.
We track market volatility because it is a reasonably reliable gauge of risk levels. 74% of the time from 1950 to 2012, when volatility in the S&P 500 goes up-that is, the average annual daily change in the price of the index (up or down) is greater than it was in the prior year-market performance declines. And when volatility declines year-over-year, market performance improves 57% of the time. And so far, 2012 is no exception: the 1Q12 S&P 500 index volatility of ±0.35% is down 65% from the ±1.01 volatility we experienced in 2011…and market performance has dramatically improved from flat in 2011 to +12% so far in 2012.
Normally, the market is remarkably stable. On average, the S&P 500 index rises or declines 0.62% each day the market is open. Actually, 52% of the time, the change in the value of the index rounds to 0% (that is, the change is less than one-half of one percent). Another 38% of the time, the change rounds to 1%.
Thus, the ±0.35% level of volatility in 1Q12 was really low…in fact, the lowest quarterly reading since 4Q06 (±0.22%). If this low level were to hold for the entire year, 2012 would then feature the least annual volatility since 1995 (±0.29%). Here is a chart that shows annual volatility levels for the past 60 years:
(click to enlarge)
After the 2008 crash, many analysts wondered if we were in for a replay of the 1930's depression. In terms of volatility, 1929 was every bit as extreme for the DJIA (DIA) as 2008 was for the S&P 500 (which itself was not created until after WWII, which is why we rely on the Dow for the 1929 data). Following the 1929 crash, volatility immediately declined sharply from the crash peak to a near-normal level in 1Q30, but then began a jig-jaggy climb that lasted through 1930 and 1931 and into 1932, peaking in 3Q32 at a level (±3.00% on average, every day the market was open!) even higher than 4Q29 had reached.
But the post-2008 pattern has been starkly-and hearteningly-different. Here is chart that compares market volatility for the two crashes:
(click to enlarge)
While the extreme volatility of 4Q08 (±3.27% up or down every day the market was open!) topped anything from the Depression, in three-plus years since then, we have not come close to replicating those heights. And more importantly, the post-crash market performance has been like day (this time) compared to night (post-1929):
| ROI | ROI | ||
| 1929 | -16% | 2008 | -38% |
| 1930 | -34% | 2009 | 23% |
| 1931 | -53% | 2010 | 13% |
| 1932 | -23% | 2011 | 0% |
| 1933 | 64% | 2012 | 12% |
Of course, the 12% for 2012 is just for the first quarter, so a lot could change. Indeed, volatility is not predictive. That is, frenetic trading does not generate a black swan event; it's the other way round. Clearly the combination of increased longer-term risk in the USA-highlighted by continuing budget and deficit issues and seeming political deadlock exacerbated by 2012 being an election year-and potential danger of sovereign debt default in Europe with the concomitant systemic risk of large bank failures, and the potential for a hard landing in China, plus macropolitical tensions (e.g., Iran, North Korea) all continue to be challenges.
The incredibly calm first quarter of 2012 may yet prove merely to be the calm before the storm. But so far, inasmuch as the market reflects the combined wisdom of investors, clearly the betting is that we have dodged the Depression bullet, and sunny skies abound. Stay tuned for further updates.
And in the meantime, if you want to hedge your bets as to how things will play out, you can effectively add the S&P 500 index to your portfolio with the SPDRs (NYSE: SPY) exchange-traded fund, or short it with the ProShares Short S&P500 (NYSE: SH). The DJIA is tracked by the Diamonds Trust (NYSE: DIA) ETF, or can be shorted with the ProShares Short Dow30 (NYSE: DOG) ETF.
Disclosure: I am long SH.
Additional disclosure: My clients may be long or short the equities mentioned.
