Tales from the Shift: How I Learned to Stop Worrying and Love the Economy
April 28, 2020
Early into 2020, we experienced two rare events which have dramatically increased volatility and disruption in global economies. Along with economic disruption comes weakness in financial markets and an innate urge to exit investments, often when the stress has peaked. Although adjustments to investment portfolios are sensical, a complete exit, in our view, can be a misstep given the durability in the financial markets can set the stage for a multi-year recovery rather than an elongated bear market.
In 2007, the term “Black Swan” was popularized by Nassim Nicholas Taleb to describe an unpredictable event with severe consequences to the economy. To say a Black Swan event only comes around “once in a blue moon” would be an exaggeration alluding to one about every two to three years. However, in 2018, we had two blue moons distanced two months apart. In a similarly unusual pattern, this year we have had two Black Swans over a short time frame: a global pandemic and an oil price war. No wonder so many feel black and blue.
One way to gauge the anxiety in the stock market is the CBOE Volatility Index, known as the VIX or “Fear Index”. The VIX is derived from price inputs of S&P 500 (SPX) index options representing the implied volatility (or dispersion of returns) expected in the SPX for the next 30 days. The lower the VIX, the narrower the trading band; the higher the VIX, the wider. The long-term average for the VIX has been towards 18, but on March 16th of this year, the VIX stretched to a new record just over 82. The VIX reached its prior high during late 2008 when it reached 80.8, smashing its previous all-time high just below 46. Still elevated, as of April 23rd, the VIX is presently at 41.3, over twice the average.
Given the rare, double Black Swan events, we would expect the VIX to stay elevated until further signs emerge of an economic recovery. The tale to be told is to welcome the tail. As the VIX tails off, as it has done historically post large spikes, the capital markets have restabilized. A key reason volatility fades is because most public companies are not a stagnant set of assets. Companies become more agile as they spring into action, resetting their business to better accommodate the environment. We are already seeing daily headlines about public companies making changes in their senior management team, strategic business shifts and measures taken to preserve liquidity. Not all the corporate changes allow stocks to immediately rise but are nonetheless designed for the long-term support of their operations. As stocks are leading indicators, our view is that their stabilization is signaling future relief from the present condition.
As the shakeout from the great recession a dozen years ago set the stage for one of the longest bull markets in history, odds are that the stock market will again be resuscitated. However, for the markets to fully rebound to prior levels, investors will be looking for signs of recovery in human and economic health. If there were a “VIX” for global pandemics, we would likely see a similar pattern including a tail forming as the medical community develops therapies to help ease the crisis. The self-help at the corporate level is also being paired up with supportive monetary injections from U.S. Treasury and central banks along with fiscal measures employed by governments. Although stock market anxiety is easing off the recent peak, it takes time to heal. Resisting the temptation to sell on the “down days” takes determination and recognition that recoveries prevail. The good news is that we aren’t likely to see a bevy of economic Black Swans approach near-term, and the next time astronomers expect us to see two blue moons in the same year isn’t until 2037.
Sources: CBOE Volatility Index (VIX) data in the above article is from ycharts.com, finance.yahoo.com and cboe.com/vix
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