Market Volatility ETF Portfolio 3Q 2017 Review: A Low-Volatility Market

Author: Leo Chen, Ph.D., Post Date: September 25, 2017

As we march through one all-time high after another in the third quarter this year, our quantitative market volatility strategy has benefited significantly from being fully invested. The leveraged portfolio has done particularly well.

The volatility index, VIX, which is highly correlated (negatively) with the equity market, made a remarkable all-time intra-day low of 8.84 and hovered around the 9-handle for quite some time before it came back to the double-digit level.

Undeniably, the US large-cap equity market is in a low-volatility environment. The “fear gauge” has ranged above a 15-handle only a handful times in 2017, and these temporary blips merely took it into the vicinity of its 5-year historical average. However, the lack of volatility is not necessarily allowing investors to sleep soundly at night. Many worry that the current market environment spells complacency. Nevertheless, if we take a look at VIX history and concurrent S&P 500 movement, we do not observe a pattern of stocks’ falling after VIX bottoms. In fact, if we compare one-year returns using a randomly selected date to one-year returns after the VIX drops to a 52-week low, we find no statistical significance between the two returns. This is because the VIX does not possess forecasting power, according to our research. (Please see our prior market commentary for details:

If the VIX cannot predict equity returns, how does it help investors? First, even though the index itself does not confer forecasting prowess, it is still, by its mathematical design, a reflection of traders’ views regarding the coming 30 days. Like CNN’s Fear & Greed Index, VIX is a contemporaneous tool that gauges market sentiment. More importantly, the VIX can be a natural hedge, owing to its negative correlation with the market. Although trading VIX may not be suitable for every investor, financial innovations available nowadays provide many channels for sophisticated market participants to utilize advanced trading vehicles at relatively low cost. For example, while one cannot buy the VIX index itself, volatility ETFs and ETNs are available. However, the tracking errors of those products may be high due to the nature of the VIX.

Overall, we believe that even though idiosyncratic events such as North Korea’s missile launches may temporarily drive up the VIX, the low-volatility environment will likely persist through the rest of the year, barring major disruptions.

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.

cumber map
Cumberland Advisors® is registered with the SEC under the Investment Advisers Act of 1940. All information contained herein is for informational purposes only and does not constitute a solicitation or offer to sell securities or investment advisory services. Such an offer can only be made in the states where Cumberland Advisors is either registered or is a Notice Filer or where an exemption from such registration or filing is available. New accounts will not be accepted unless and until all local regulations have been satisfied. This presentation does not purport to be a complete description of our performance or investment services. Please feel free to forward our commentaries (with proper attribution) to others who may be interested. It is not our intention to state or imply in any manner that past results and profitability is an indication of future performance. All material presented is compiled from sources believed to be reliable. However, accuracy cannot be guaranteed.