Volatility At Historic Lows, Can The Bull Market Continue

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The Longest Bull Market In History And What Happens Next

Barring a breathtaking plunge, the bull market in U.S. stocks on Aug. 22 will become the longest in history, and optimistic investors argue it has miles to go before it rests. – Sue Chang, MarketWatch

Depending on how you measure beginnings and endings, or what constitutes a bear market or the beginning of a bull market, makes the statement a bit subjective. However, there is little argument the current bull market has had an exceptionally long life-span.

But rather than a “siren’s song” luring investors into the market, maybe it should serve as a warning.

Record levels” of anything are records for a reason.

It should be remembered that when records are broken that was the point where previous limits were reached. Also, just as in horse racing, sprinting or car races, the difference between an old record and a new one are often measured in fractions of a second.

Therefore, when a “record level” is reached it is NOT THE BEGINNING, but rather an indication of the PEAK of a cycle. Records, while they are often broken, are often only breached by a small amount, rather than a great stretch. While the media has focused on record low unemployment, record stock market levels, and record confidence as signs of an ongoing economic recovery, history suggests caution. For investors, everything is always at its best at the end of a cycle rather than the beginning.

The chart below has been floating around the “web” in several forms as “evidence” that investors should just stay invested at all times and not worry about the downturns. When taken at “face value,” it certainly appears to be the case. (The chart is based up Shiller’s monthly data and is inflation-adjusted total returns.)

The problem is the entire chart is incredibly deceptive.

More importantly, for those saving and investing for their retirement, it’s dangerous.

The first problem is the most obvious, and a topic I have addressed many times in past missives, you must worry about corrections.

Most investors don’t start seriously saving for retirement until they are in their mid-40’s. This is because by the time they graduate college, land a job, get married, have kids and send them off to college, a real push toward saving for retirement is tough to do as incomes, while growing, haven’t reached their peak. This leaves most individuals with just 20 to 25 productive work years before retirement age to achieve investment goals.

This is where the problem is. There are periods in history, where returns over a 20-year period have been close to zero or even negative.

Currently, we are in one of those periods.

Lies, Damned Lies And Statistics

Secondly, percentages are deceptive.

Back to the first chart above, while the mainstream media and bloggers love to talk about gains and losses in terms of percentages, it is not an apples to apples comparison.

Let’s look at the math.

Assume that an index goes from 1000 to 8000.

  • 1000 to 2000 = 100% return
  • 1000 to 3000 = 200% return
  • 1000 to 4000 = 300% return
  • 1000 to 8000 = 700% return

A 700% return is outstanding, so why worry about a 50% correction in the market when you just gained 700%?

Here is the problem with percentages.

A 50% correction does NOT leave you with a 650% gain.

A 50% correction is a subtraction of 4000 points which reduces your 700% gain to just 300%.

Then the problem now becomes the issue of having to regain those 4000 lost points just to break even.

Let’s look at the S&P 500 inflation-adjusted total return index in a different manner.

The first chart shows all of the measurement lines for all the previous bull and bear markets with the number of years required to get back to even.

What you should notice is that while the original chart above certainly makes it appear as if “bear markets” are no “big deal,” the reality is that in many cases bear markets wiped out essentially a substantial portion, if not all, of the the previous bull market advance. This is shown more clearly when we convert the percentage chart above into a point chart as shown below.

Here is another way to view the same data. The table and chart below overlays the point AND percentage of gain and loss for each bull and bear market period going back to 1900 (inflation-adjusted).

Again, the important thing to note is that while record “bull markets” are a great thing in the short-term, they are just one half of the full-market cycle. With regularity, the following decline has mostly erased the previous gain.

Broken Records

While the financial media is anticipating a new “record” being set for this “bull market,” here is something to think about.

  • Bull markets END when everything is as “good as it can get.”
  • Bear markets END when things simply can’t “get any worse.”

While everything is certainly firing on all cylinders in the market and economy currently, for investors this should be taken as a warning sign rather than an invitation to pile on additional risk.

In the near term, over the next several months, or even a year, markets could very likely continue their bullish trend as long as nothing upsets the balance of investor confidence and market liquidity.

This bull market will easily set a “new bull market record.”

But, as I said, “records are records” for a reason. As Ben Graham stated back in 1959:

The more it changes, the more it’s the same thing.’ I have always thought this motto applied to the stock market better than anywhere else. Now the really important part of the proverb is the phrase, ‘the more it changes.’

The economic world has changed radically and will change even more. Most people think now that the essential nature of the stock market has been undergoing a corresponding change. But if my cliché is sound, then the stock market will continue to be essentially what it always was in the past, a place where a big bull market is inevitably followed by a big bear market.

In other words, a place where today’s free lunches are paid for doubly tomorrow. In the light of recent experience, I think the present level of the stock market is an extremely dangerous one.

He is right, of course, things are little different now than they were then.

For every “bull market” there MUST be a “bear market.”

While “passive indexing” sounds like a winning approach to “pace” the markets during the late stages of an advance, it is worth remembering “passive” approaches will also “pace” the decline.

Understanding that your investment returns are driven by actual dollar losses, and not percentages, is important in the comprehension of what a devastating effect corrections have on your financial outcome. So, before sticking your head in the sand and ignoring market risk based on an article touting “long-term investing always wins,” ask yourself who really benefits?

This time will not be “different.”

If the last two bear markets haven’t taught you this by now, I am not sure what will.

Maybe the third time will be the “charm.”

Historical Volatility: A Timeline of the Biggest Volatility Cycles

Throughout history there have been a number of extremely meaningful volatility spikes across major financial markets. Each had defining characteristics that made them similar, despite occurring in very different markets and for different reasons.

The continuity seen across these volatility cycles is a good thing, because while it doesn’t necessarily make a major volatility spike highly predictable, historical precedence offer a blueprint for identifying conditions that are supportive for a potential vol-event to occur, and how they are likely to unfold once in motion. T his can be of great help in guiding trading decisions, whether that is to steer clear of a potential vol blow-up or move towards it with the appropriate strategy that can take advantage of the outsized price swings that come with unusual levels of volatility.

We will first discuss what a volatility event typically looks like in terms of the behavior of volatility itself, then take a close look at some of the largest spikes ever witnessed in major financial markets.

Get your report on the impact of market volatility here .

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What is Volatility?

“In simple terms, volatility can be defined as the variations at which a market fluctuates. The more an asset’s price moves , the higher the volatility – the less the price moves , the lower the volatility.”

– Paul Robinson, DailyFX

In this piece we are looking at a short-term measure of volatility (two-week duration) called Realized Volatility, which is volatility as it has already occurred. It is also known as Historical Volatility.

What Does a Volatility Event Cycle Look Like?

In the lead-up to a volatility spike, t here is often a build-up period where volatility rises gradually, indicating markets could be headed for significant dislocation and disruption. The period of subtle unrest is followed by a sudden, vertical move in volatility that reaches a climax before quickly reversing and normalizing through a gradual, but bumpy decline towards pre-event volatility levels.

The graph below is a composite of several past volatility cycles, accounting for 100 days before and after the peak in volatility. Notice the build-up period, the volatility spike itself, and the normalization phase, as well as the asymmetry between the phases.

Cycle of a volatility spike

Behavior of Volatility Differs Among Asset Classes

Another aspect of market volatility to understand is that it doesn’t behave in the same way across all asset classes, nor necessarily even within the same asset class. For example, stock market volatility generally behaves much differently than it does in currencies and commodities.

Stocks have an inhe rent long bias to them, as they are generally an asset of appreciating value over the long run.

Market participants invest in company shares, making the stock market almost an exclusively long market with limited short interest. Because of this bias , volatility runs high in down markets when there is fear as a result of financial losses and selling, and low in up markets where fear is minimal.

Occasionally, you will see stock market volatility rise in a bull market as participants collectively suffer from FOMO , but this isn’t the norm and only happens towards the end of long, powerful trends – a couple of which we will look at here shortly.

VIX demonstrates that volatility rises on selling, declines on buying

A s shown in the graph above, volatility typically runs opposite of the S&P 500, especially when the market declines.

Over the long-run, currencies and commodities don’t have a natural bias to them and tend to oscillate in large bull and bear cycles that end in minimal net change. Volatility can rise in either direction and isn’t consistent over time. In the case of commodities (i.e. gold), volatility can actually be more likely to rise with a price rise than during a decline. But again, this is not wholly consistent across a cycle.

Gold vs two-week realized volatility

In the graph above , the green boxes mark periods when volatility rose while price appreciated, and the red boxes mark periods when it rose while the price of gold depreciated. This highlights the non-directional bias that volatility can have in commodities – the same also holds true for currency volatility .

A History of Market Volatility: The Biggest Volatility Cycles

We’ll have a look at the most significant volatility cycles that have happened in the major financial markets since 1929 and investigate their build-up, peak, normalization phase and after-effects.

Crash of 1929

At the end of the roaring ‘20s ’ bull market , the crash of 1929 kicked off the Great Depression of the 1930s. The October 28-29 crash in 1929 is particularly noteworthy and resulted in a two-day loss of 24% in the Dow Jones Industrials Average, with two-week realized volatility rocketing to 127%. In the short-term aftermath, the Dow price spent the next two weeks closing 6% higher or lower from the prior day’ s session.

As was the case with the death of other major historical stock markets, the crash didn’t come from all-time highs (ATH), but after a period of weakness that caused volatility to rise ahead of the major spike. Heading into the late-October rout, the market was already off the ATH by 21% with short-term volatility rising from only 11% to 81%.

After the initial episode of the 1929-1932 stock market decline, volatility initially normalized by falling from a two-week reading of 127% to under 10% in about five months’ time. Volatility would ramp up again later, but did not exceed 100% again until almost two years later , when the worst part of the bear market drew near its conclusion.

Dow Jones Industrial Average: 1929-1931

In the chart above , v olatility spiked sharply (red) after weeks of rising in an unsteady market (orange) , then dropped sharply (green) as market confidence firmed up in the wake of the two-day crash.

Silver 1980

During the late 1970s/80 s period , the Hunt brothers attempted to manipulate the price of silver in what was one of the most famous market ‘cornerings’ ever. It wasn’t just the brothers ’ trading activity though : inflation was rapidly rising, and precious metal hedges were in high demand. Silver topped out at over $49 after trading only $6 a year prior.

During the spectacular price rise, volatility at times rose sharply with each major surge, including the final one that concluded in January 1980. Volatility declined during the initial portion of the sell-off before spiking to near record levels as the market panicked out of long positions during the spring of 1980. From there it was a bumpy ride, but the two -week realized volatility declined to only 12% a mere five months after super-spiking to 240%.

In this chart, the green boxes highlight the volatility spikes during bullish phases and the red boxes when volatility spiked on selling. It is clear there was a larger tendency for volatility to rise with the price of silver versus when it fell.

Black Monday – 1987

The 1987 stock market crash in the United States was in large part blamed on ‘program trading’, the first technology/financial engineering – driven crash of its kind. However, massive speculative excesses were built up prior to the crash , unlike anything since the 1920s . T his played a significant role in the decline of stock prices and the massive spike in volatility.

The one – day , 20%+ decline in the major averages was of course a significant surprise – outside the possibility of predicting – but just as has been the case with most other major volatility cycles , it didn’t exactly occur out of the blue.

During the last

10% of the bull market , two-week realized volatility rose with the S&P 500 from 8% to 15%, highlighting growing instability in the up t rend. By the time Black Monday rolled around , the SPX had already declined from the high by 16% while volatility was materially higher with a short-term reading of 25%.

Short-term volatility spiked to over 130% in the wake of the Monday collapse in stock prices before easing off and eventually dropping back to near 10% by the following March.

Growing unrest (orange) shows volatility increasing as the market is still in a bullish phase. When Black Monday rolled around, volatility went spiraling higher (red) before dropping off after the market stabilized (green).

Great Financial Crisis (GFC) 2008

The Great Financial Crisis was driven by irresponsible banking practices on Wall St. that eventually came at the cost of Main St. The decline from 2007 to 2009 was the largest plunge in both stocks and the economy since the Great Depression, but it wasn’t without some type of warning that a major blow-up in volatility could be in the works.

Just before things got really wild in the fall of 2008, two-week volatility was already at 41%. From there , the S&P 500 fell another 27% in about five weeks, which saw short-term volatility rocket to 97%. During that time , the widely – watched VIX index exploded from 36 to 80. In the year following, volatility normalized with two-week realized vol and the VIX hitting 20% and 23, respectively.

But even going back to 2007 before the bear market began, like in so many other bull markets nearing their conclusion, volatility began creeping higher. Despite the S&P 500 having rose about 8% YTD up to the October 9, 2007 high, the VIX itself had also rose from around 12 to 16 – a 25% increase. The wheels on the bus were beginning to wobble despite all looking well on the surface.

Looking at the chart above , one can see volatility was generally heading higher (orange) prior to the big spike in 2008. Once panic hit a zenith (red) and market confidence came back, volatility died down (green).

Turning to currencies, one of the biggest casualties of the Great Financial Crisis was the Australian Dollar ( AUD/USD ), which plunged nearly 40% while two-week volatility spiked to 80% from just single digit levels a few months earlier. Australia’s strong export ties to China proved to be costly when the emerging economy’s growth rate took a serious hit during the global recession.

The rout wasn’t a total surprise, as few are; volatility rose steadily in the months prior to the final collapse of Aussie. Short-term volatility climbed from a mere 5% in July 2008 to nearly 30% before the final spike to 80% occurred into October. Once AUD/USD bottomed there was a fairly sharp drop in volatility before it tapered off during the first few months of 2009.

Other currency pairs were also hit in a big way, such as EUR/USD and USD/CAD , but volatility never escalated like it did in AUD/USD. Volatility in those pairs rose to ‘only’ 30-40%, which is still extremely high for currencies.

S&P 500 E-Mini Flash-Crash 2020

The first major flash-crash to speak of occurred on May 6, 2020, when the S&P 500 e-mini futures were rocked by over 6% in about seven minutes before erasing all losses in less than fifteen minutes.

A London -based trader, Navinder Singh Sarao, was accused and found guilty of ‘spoofing’ – the placing of large orders which are cancelled just before getting filled.

Now while this may have contributed to the decline, the market was already in a fragile state to begin with, as is typically the case when flash-crashes occur. To put volatility into perspective, the VIX had risen from 15 to 25 in the weeks prior, before rocketing past 40 on the day of the crash. Volatility actually didn’t finish rising until about three weeks later when the VIX hit 48. From there , volatility declined in typical fashion until early 2020 before popping again.

The S&P 500 e-mini flash-crash showed a familiar theme: the orange highlights a period where stocks were still generally heading higher but the unrest underneath the hood was becoming apparent via rising volatility. The spike and higher level s of volatility (red) followed suit along with the May 6 flash-crash.

EURCHF blow-up 2020

Of the blow-ups in volatility, this was one of the most surprising. The Swiss National Bank (SNB) had a floor in the EUR/CHF exchange rate that caused wide-spread complacency in the market and fueled the ‘thinking’ that the central bank would keep the cross supported. As it turned out , this was not the case.

When the SNB yanked the floor, EUR/CHF collapsed from 1.20 – depending on the quote source – to as low as 0.68. Short-term volatility went from virtually zero to nearly 100% in a flash. It only took days to take back most of the spike, but vol spent the next three months slowly normalizing.

With the SNB floor in place volatility dropped to nearly zero (orange), but once the floor was lifted the market was caught off guard, causing volatility to rocket to over 100% (red) before backing off once the dust had settled (green).

Brexit 2020

The Brexit vote in June 2020 wasn’t expected, despite it being a possibility, as evidenced by the way markets were railroaded when the vote came out in favor of the UK leaving the European Union . Sterling was in a near-term upswing right before the results were announced, but GBP/USD ended up closing down 8% on the day the vote was finalized. Two-week realized vol exceeded 46% thereafter.

This was a known event to take place, so there was no surprise to see volatility rise ahead of time in anticipation – nevertheless, volatility provided a warning that things could get dicey. In the month before the vote , two-week realized volatility rose from a mere 6% to over 16% as market participants weighed in on the potential outcome, one that the market wasn’t fully prepared to handle even with warning .

Post-Brexit vote, vol atility initially cratered from 46% back to 16% in only about a month before entering the typical post-event grind towards normalization of around 7% in six weeks’ time. A few months after that there was the Pound flash-crash in October that again saw volatility spiral higher momentarily.

Above it can be seen that volatility rose in anticipation of the Brexit vote (orange), then rose sharply on the surprise Brexit outcome (red) to eventually fade in the aftermath (green).

Volpocalypse 2020

The ‘Volpocalypse’ of February 2020, while nowhere near as dramatic and damaging as the ’87 crash, didn’t exactly happen out of the blue . In the final months of 2020, U.S. stocks accelerated higher in an unsustainable fashion, taking vol with it – two-week realized volatility rose from just 3% at the end of September to around 8% at its peak in January 2020.

After stocks peaked in late January, the market began to decline for about a week before the indices plunged and volatility shot up. The Dow experienced a 4% flash-crash in the span of about ten minutes.

The VIX, the most popular measure of broad stock market volatility, saw an extremely unusual spike as the market was caught betting heavily on low levels of volatility via futures, options, and ETFs aimed at direct bets on the level of the VIX. This caused an exaggerated move in the VIX that pushed it to an intra-day high of 50. Like most vol blow-ups, this one too spent several months normalizing to pre-event levels.

S&P 500 and VIX: 2020

Above, you ca n see that volatility began rising during the last stage of the blow-off rally as it became unstable (green) and rose further on price weakness before super-spiking on a sharp decline in stock prices (red), followed by a period of normalization (orange).

VIX Hits 50 intra-day

The intra-day VIX spike was much larger than the actual stock market decline would have caused under ‘normal’ circumstances, but massive short VIX bets helped fuel it much higher.

Market Volatility Going Forward

Major volatility events have always been a part of financial markets and always will be. Understanding what they look like and having historical precedence to operate as blueprints offers traders a framework to operate within going forward .

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Is the recent stock market volatility a sign that the 10 year bull market is over?

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Not sure how you arrive at 20 years its more like 10 years still a record the largest and longest bull market run before our current one was in the roaring 20’s from 1921 to 1929 or roughly 8 years the current bull market in March 2020 crossed the 10 year mark and who knows when the end is nigh? Yes volatility can be a sign of the impending market collapse however when it does eventually happen you can be assured that it will take everyone by surprise it always seems to happen when you least expect it, lets look at 2 of the worst crashes in stock market history that of 1929 and 1987 the fir.

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