Will Market Volatility Return This Year?

2020 is in the rearview mirror, and I think we can all agree that it’s a good thing. While last year was certainly interesting for investors, I don’t think anyone wants to relive the other parts of 2020. The year is, of course, marked by the start of the COVID-19 pandemic. But let’s not forget massive forest fires, tireless political drama, and a host of other negative headlines.

For the stock market, one defining feature of 2020 was persistent high volatility. Volatility spiked to record-high levels during the March COVID-19 crash. It remained elevated for the remainder of the year.

To put it in perspective, let’s look at the VIX – the S&P 500 Implied Volatility index – the most popular measure of market volatility. In a “normal” year, the VIX will rarely reach 20, much less spend weeks or months above that level. In 2020, the VIX climbed above 20 in February and has yet to close below it as we head into 2021.

The sustained elevation in the VIX really shouldn’t be that much of a surprise given the pandemic’s scope and severity. COVID-19 has taken a substantial toll on the global economy (to say nothing of the awful loss of human lives). The economy will continue to suffer as the world waits for the slow rollout of the COVID vaccine.

The multiple vaccines available or becoming available give reason for hope. There may be something akin to normalcy in 2021. Nevertheless, volatility hasn’t shown much inclination to return to more modest levels. Does that mean we can expect higher volatility for the foreseeable future?

The thing is, volatility tends to cluster at higher levels after a significant market dislocation, as we had in March. The aftereffect of a crash can be quite severe. What’s more, there are a lot fewer volatility sellers these days. 2020 was not kind to systematic volatility selling strategies.

Eventually, especially as the vaccine becomes more available, volatility is likely to drift lower. However, it may take longer than expected. There are even some short-term bets that volatility could spike again in January.

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