By John Q. Frank, CFA, QQQ Equity Product Strategist
Equity market volatility has been remarkably low in recent years, which has corresponded to strong large-company equity performance — particularly for the Nasdaq-100 Index and the S&P 500 Index. This has led some market observers to wonder whether we’re due for a correction of sorts in volatility, much as stocks might correct after a bull market. Barring major geopolitical disruptions, I don’t see evidence that this will be the case.
The CBOE NASDAQ Volatility Index (the VXN) is the Nasdaq-100’s version of the CBOE Volatility Index (the VIX), which measures the volatility of the S&P 500 Index and is perhaps the most commonly cited barometer of near-term equity market volatility. The VXN reflects the option market’s estimate of future volatility for the Nasdaq-100 Index. Since October 2008, shortly after the collapse of Lehman Brothers, these two measures of volatility have tracked each other closely. In fact, from November 2008 through July 2017, the monthly correlation between the VXN and the VIX was almost perfect at 0.99 — even higher than the 0.81 correlation between the indices from February 2001 to mid-September 2017.1
Volatility measures have diverged of late
Late June saw the VXN move to a level 6.4 units higher than the VIX — the largest difference since January 2007. From July 1 through Sept. 13, however, the VXN decreased 27% to 12.8, while the VIX increased 3% to 10.9 — resulting in a spread of 1.9.1 These movements can be seen in the chart below.
Volatility measures: CBOE NASDAQ Volatility Index vs. CBOE Volatility Index
Feb. 28, 2001 – Sept. 13, 2017
Lower volatility has resulted in more consistent returns
So what has volatility meant for large-cap equity performance? Over the past 30 years, lower levels of market volatility have generally corresponded with higher returns and lower peak-to-trough losses, known as drawdowns, each calendar year. The chart below, with bars represented by calendar-year total returns and dots representing maximum annual drawdowns, shows that returns tend to be lower when volatility is high, with 2000-2002, 2008 and 2011 as examples.
The relationship between returns and drawdowns: Nasdaq-100 Index, S&P 500 Index, 1988-2017
Calendar-year returns (bars) vs. maximum annual drawdown (points)
As you can see, beginning in 2009, both the Nasdaq-100 Index and S&P 500 Index generated positive returns for eight consecutive years, with 2017 on pace to potentially be the ninth such year.
Also note the drawdown points. Over its 30-year history through Sept. 13, 2017, the Nasdaq-100 Index’s largest average annual decline was -19.7%, compared with -13.3% for the S&P 500 Index. Post-financial crisis, however, these averages were -12.0% for the Nasdaq-100 Index and -12.3% for the S&P 500 Index. Not surprisingly, periods of lower volatility during this time have coincided with lower maximum drawdowns.
What is the outlook for volatility?
Going forward, I expect volatility levels for the Nasdaq-100 Index to remain low, as we have witnessed the correlation between the current month and the following month to be high (0.92).1 Additionally, the correlation for volatility in a given month and volatility in the subsequent three months is significant (0.79).1 As such, I don’t anticipate volatility levels to revert to mean anytime soon.
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1 Source: Bloomberg L.P., as of Sept. 13, 2017
Correlation is the degree to which two investments or indexes have historically moved in relation to each other.
Volatility is a statistical measurement of the magnitude of up and down asset price fluctuations over time.
Past performance cannot guarantee future results. Index returns do not represent fund returns. An investment cannot be made directly in an index.
The CBOE Volatility Index (VIX) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, which shows the market’s expectation of 30-day volatility.
The CBOE NASDAQ-100 Volatility Index (VXN) is a key measure of market expectations of near-term volatility conveyed by NASDAQ-100 Index (NDX) option prices. The index measures the market’s expectation of 30-day volatility implicit in the prices of near-term NASDAQ-100 options.
The Nasdaq-100 Index includes 100 of the largest domestic and international non-financial securities listed on the NASDAQ Stock Market based on market capitalization.
The S&P 500 Index is an unmanaged index considered representative of the US stock market.
John Q. Frank, CFA
QQQ Equity Product Strategist
PowerShares by Invesco
John Frank is the QQQ Equity Product Strategist representing the PowerShares family of exchange-traded funds (ETFs). In this role, Mr. Frank works on researching, developing product-specific strategies and creating thought leadership to position and promote the PowerShares QQQ.
Prior to joining PowerShares, Mr. Frank was an Assistant Portfolio Manager at RS Core Capital, a multi-asset class investment firm. In this role, his primary responsibilities included research, risk management and asset allocation with a focus on the equity and hedge portfolios. Before RS Core Capital, he spent six years at J.P. Morgan Asset Management advising institutional investors on asset/liability management, asset allocation and pension regulation and worked across the defined benefit, defined contribution, endowment and foundation segments. He began his career at General Electric in a leadership development program where he was placed within the GE Energy division.
Mr. Frank earned a BSE degree in industrial & operations engineering from the University of Michigan – Ann Arbor and an MBA with Honors from the University of Chicago Booth School of Business with concentrations in analytic finance, econometrics, and statistics. He is a CFA charterholder and a member of the CFA Society of Chicago as well as the Beta Gamma Sigma Society.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.