The US stock market experienced some rising volatility caused by the tariff war during the second quarter of 2019. While the S&P 500 didn’t drop by double digits in May, the volatility index, VIX, briefly touched above 20 last month. As a general rule of thumb, investors can expect a 10% correction in the stock market every year on average (though 10% is an arbitrary number and not a definitive probability). Even though the market went back up to the 2,900 level fairly quickly after the Fed signaled a possible rate cut, volatility did not follow the market rally with a proportional decrease. This could be a sign that investors have not downgraded the geopolitical risks, such as the trade war, that are embedded in the stock market.
Stock market volatility had been trending downward prior to the US’s enforcing the 25% tariff on Chinese imports. The VIX sank to an 11-level as the equity market made new all-time highs in April. The low VIX was viewed as a sign of complacency by many market participants, as the stock market staged an over 20% comeback in just four months. Interestingly, although the market is only 2% away from its all-time high, the current VIX is significantly higher than April’s low level. Although volatility is usually not the stock market’s best friend, the “uneased” volatility could be what the market needed if it were going to make another new high. Rallies tend to be fragile if volatility is simultaneously suppressed. However, a moderately high VIX suggests that traders are positioned for some downside potential. If the market can rally in this environment, that’s a healthy sign that the market may be able to set another all-time high.
Our quantitative strategy exited the last tranche and went to all cash in April. We are currently holding cash at a 2% yield, waiting for the next entry. If you have any questions, please do not hesitate to contact me.
Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
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