Volatility And Mean Reversion

“Don’t confuse lack of volatility with stability, ever.” – Nassim Taleb

Volatility is low. How low?

Over the past month, the Dow Jones Industrials Average has traded in a range (from high to low) of 1.4%. Going back to 1970, that’s the least volatile period in history.

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At 2.2%, the same range for the S&P 500 is not the lowest ever, but it’s close. 

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The Volatility Index (VIX) closed yesterday at 11.26, lower than 97% of historical readings going back to 1990. 

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What does this mean for markets going forward?

Not as much as one would think, as I wrote about last July when the VIX was at a similar level (below 12). The forward S&P 500 returns from the lowest VIX decile, while slightly below average, are still strong.

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Low volatility, then, is not by itself a contrarian sell signal. That doesn’t mean that stocks have never gone down following periods of low volatility (they have), just that they don’t have to go down and are much more likely to go up.

Perhaps the only intelligent thing that can be said about periods of extremely low volatility is that they tend to be followed by periods of higher volatility. Volatility is mean reverting. We should be prepared for it to rise from here.

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