After spiking by 49% on the Brexit vote, the VIX quickly settled back down to levels not seen in over two years. But that all changed late last week, when market participants began to realize that the probability of a rate hike in the near future was much higher than previously thought. As global bond and stock markets sold off, the VIX shot up by 40% on Friday. There was seemingly nowhere to hide, as not one of the 60 or so indices that we track, covering equities, fixed income, commodities and currencies, was able to post a gain. Consider that the areas investors typically flock to in periods of stress, like Treasuries and gold, provided little comfort, as the Barclays US Treasury 20+ Year index fell 1.3% and the LBMA Gold PM price was down 0.9%. But with a new day comes yet another change in outlook, and despite the fact that Asian and European markets experienced meaningful losses overnight, US equity markets are once again up and the VIX is retreating.
What’s the point, you may ask? In a period when many advisors who we speak with have expressed deep frustration with the inability of a diversified portfolio to keep up with U.S. equities, it’s worth remembering that over the short to medium term, we are all at the mercy of what the market gods deliver in terms of return; that can’t be controlled. But risk can and must be managed to a level consistent with the goals of the client, as anticipating these rogue waves of volatility in an otherwise artificially calm sea is all but impossible. With an estimated $14 trillion or so in negative yielding government bonds, a CAPE of close to 27 times earnings, and very much human central bankers seemingly at a loss for how to manage the Great Unwind, giving in to the desire to toss diversifiers in an attempt to keep up with the S&P would seem to be foolhardy.