Tracking Volatility Cycles

 |  Includes: AGG, DIA, DJP, EEM, EFA, IWV, QQQ, SPY, TIP, VNQ
by: James Picerno

It comes as no surprise to learn that volatility in the capital and commodity markets has been rising of late. Confusion and uncertainty (both of which have been in surplus in recent months with regards to economics and finance) typically sow the seeds of wider trading ranges. Monitoring volatility is no short cut to easy profits, of course, but as we've discussed from time to time, the ebb and flow of volatility sometimes offers strategic-minded investors some valuable clues about investment cycles.

With that in mind, below we present a freshly updated chart of rolling 36-month volatility over time for several major asset classes, with data through March 31, 2008. Consider that volatility looked unusually low in '06 and '07, which we now know was a prelude to a reversal. Note too that trailing returns back in '06 and the first half of '07 looked exceptionally strong across the major asset classes. The two trends looked long in the tooth, suggesting that the cycle was poised to turn. And turn it did. But now that it's turned, what's next?

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That's always a relevant question and it's forever unclear in real time. To the extent that strategic-minded investors can generate informed guesses about the future, tracking volatility cycles is one among many factors to survey on a regular basis. For the moment, there are no obvious signals springing from volatility, at least nothing comparable to the signs of '06 and '07. As such, volatility remains one more metric we watch and will continue watching, always in context with other factors, starting with valuation.

In the meantime, volatility has been rising and returns have been falling. But, at some point, that too will end. Cycles, in short, remain very much alive and kicking.