Earlier this month, we noted that based on futures and options data, investors were still hedging their positions and were not fully allocated for a large recovery year-over-year (YOY) in economic growth and corporate profitability. Another way we try to measure and monitor this is by looking at trailing volatility.
There are a large, growing number of systematic and target volatility strategies that have restrictions around how much variability they can have in their portfolios. This is usually measured by standard deviation and mostly calculated based on trailing realized volatility (some will utilize implied volatility where applicable). When trailing volatility levels are very high (on an absolute basis or relative to a target/benchmark), investment managers that utilize this as an input are forced to lower their exposure to assets with high volatility in order to be in compliance with their objectives. Research firm, Hedgeye Risk Management, noted in a recent update that trailing 260 (one calendar trading year) volatility for the S&P 500 was in the 96th percentile going back to 1990.
We can highlight a similar point by looking across a few different asset classes.
On the equity side, one-month volatility for energy stocks has been declining at a rapid pace, while one-month volatility for utility stocks has been increasing.
On the commodity side, one-month volatility for WTI (oil) has been declining since November, while gold volatility has been increasing.
On the currency side, the volatility of the U.S. Dollar index (DXY) has been increasing, while the volatility of the U.S. Dollar/Indian Rupee pair has been declining.
In fixed income, the volatility of bank loans and high yield have been declining steadily for many months and are back to being much lower than longer-duration Treasuries.
These charts are meant to serve as illustrations of a trend regarding the improving volatility on an absolute and relative basis for assets that typically have higher realized volatility than peers, although this is not exactly how these strategies utilize this data. This trend is normal during periods of economic and corporate profit recoveries and is an indication that investors may start to increase their allocation to risk assets as the math that drives their strategies starts to allow for large position sizing.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC