"The flipside of volatility is opportunity."
- John P. Calamos, Sr.
The typical investor doesn't like volatility. As we sock our money away and invest for the future, we'd all love to see our portfolios grow at a steady, uninterrupted pace — and faster would be nice, if anyone's asking. But that's not how investing works. There is no "free lunch"— in other words, there's no reward without some risk. If there were reward without risk, overnight savings accounts and short-term notes would pay more than long-term bonds and the stock market.
In recent months, the markets have become increasingly volatile. Many investors are apprehensive about what this means for their portfolios. But, it's important to understand what volatility is — and what it isn't. An increase in volatility doesn't signify bad news on the horizon. Volatility stems from investors' perceptions, not fundamentals. An increase in volatility is simply an indication that investors are less certain today than they were yesterday.
In fact, increased volatility may actually have a silver lining. History has shown that increased volatility, as measured by the VIX Index*, has typically led to better, not worse, days for the stock market.
Historical Performance Following a Spike in Volatility
Investors may worry about staying in the markets during volatile periods. However, increased volatility has typically been a positive event. As shown below, stocks have often posted solid gains after a spike in volatility.
| Date of Spike |
VIX % change from 50 days ago |
Equity Market (S&P 500 Index) % Change After Spike |
| 1 month later |
3 months later |
6 months later |
12 months later |
| 8/23/1990 |
109.8% |
1.7% |
3.9% |
21.3% |
31.9% |
| 4/4/1994 |
113.9% |
3.4% |
2.4% |
6.8% |
17.6% |
| 8/31/1998 |
104.9% |
6.4% |
22.0% |
30.3% |
40.2% |
| 9/17/2001 |
119.1% |
5.8% |
8.5% |
13.1% |
-12.9% |
| 7/22/2002 |
94.2% |
16.0% |
10.2% |
9.3% |
21.6% |
| 6/13/2006 |
109.0% |
3.0% |
7.8% |
16.4% |
24.3% |
Past performance is no guarantee of future results.
Source: Bloomberg, LP. |
Putting the Volatility Surge into Context
When evaluating the recent spike in volatility, it's important to keep a long-term perspective. Over the past few years, investors have enjoyed a prolonged period of extraordinarily low volatility. Accommodative fiscal and monetary policies ushered in an economic recovery which may have led investors to reduce their perceptions of risk. In this environment, the VIX Index stayed at very low levels for the better part of four years.
Volatility fell from nearly 40 on September 30, 2002 to an uncharacteristically low 10 on January 31, 2007. As of the end of August, it has climbed back to a more normal 24. Therefore, the surge seen in recent months may be more appropriately viewed as a "reversion to the mean," or a return to what might be considered more normal levels.
What has caused investors to reassess their views on what was "near certainty" only a few months ago? The timing of the jump suggests increased concerns about credit risks and borrowing costs, as well as apprehension that cyclical and lower-earnings quality businesses may be particularly vulnerable to an eventual slowing of the recovery-rate growth that had driven their momentum over recent years.
| The Recent Increase in Volatility Represents a Return to More Normal Levels |
The short-term perspective:
Volatility has spiked dramatically over the past year
Volatility (VIX Index)
August 25, 2006 through August 31, 2007
 |
The long-term perspective:
Current volatility is not extreme
Volatility (VIX Index)
January 2, 1990 through August 31, 2007
 |
Source: FactSet
Turning Volatility into Opportunity
Practiced sailors understand how to work with the changing winds and tides to reach their destination speedily — and safely. Similarly, successful long-term investing requires far more than catching the momentum of a single chance tailwind. Instead, it requires a deliberate and long-term approach, guided by fundamental research skills and a keen awareness of risk.
During the period of low volatility leading into 2007, market participants turned a blind eye to risk. Lower-quality and cyclical companies led, while those with quality fundamentals were often overlooked. We were concerned that these leadership trends were not sustainable. Accordingly, throughout 2006, we favored quality growth companies over cyclical and speculative investments. While this contributed to the relative underperformance of some of our strategies during 2006's momentum-driven market, we believe recent events in the markets have validated our stance.
As a more typical level of volatility has returned to the market, we have seen the benefits of our more traditional investment approach affirmed. Investors have increasingly rewarded companies with sound fundamentals and better prospects for earnings growth. Meanwhile, momentum investors who favored lower-quality assets seem to be paying the steepest price.
We are confident in the current positioning of our strategies and remain fully invested. Guided by the compass of our risk-conscious philosophy, we believe we are well positioned to sail forward and to use volatility to our long-term advantage.