Recommendation: Prepare your portfolio for rising volatility (Part 2 of 3)
Why? Despite recent market swings, volatility is still very low by historic standards. Even at its peak on Thursday, equity market volatility, as measured by the VIX Index (VXX), only reached 15, roughly 25% below the long-term average, and by midday Monday, it was back down to around 13.
Market Realist – VIX index levels have been low, as you can see from the graph below. The current volatility levels are hovering around 13. This is below the long-term average.
Market Realist – Despite the low levels, you need to be cautious. The sudden spike in volatility we saw on July 17, 2014, could signify an greater rise in volatility. The graph below shows volatility in July 2014.
Low volatility suggests markets are complacent and not taking into account the prospect of bad news. Indeed, there is no shortage of potential triggers for more turbulence ahead.
To begin, geopolitical risk is clearly rising. If nothing else, last week’s tragedy in Ukraine demonstrated that the unrest in the eastern part of the country is far from over. Meanwhile, we are witnessing the continued fragmentation of Iraq and now a ground war between Israel and Hamas in Gaza.
Market Realist – A rise in geopolitical risks could mean a rise in volatility.
Markets don’t respond well to uncertainty. The news of the Malaysian Airlines tragedy caused a dip in markets around the world. The airline industry, particularly, was the worst hit. The stocks of all major U.S. airlines plummeted in response to the news. Delta Air Lines (DAL) fell 3.4%, United Continental (UAL) fell 3.9%, and American Airlines (AAL) fell 3.3%.
The bond market also felt the effects of the crash. Prices rose while yields for ten-year government bonds (IEF) fell to 2.45%. Gold (GLD) and silver (SLV) both rose—by 1.5% and 2.2%, respectively.
This shows how one event can trigger far-reaching effects in the markets. With geopolitical risks gaining on the horizon, uncertainty and volatility are set to rise.
Read on to find out what you need to look out for and what your strategy should be to face rising volatility.
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