The historical 20-day volatility of the S&P 500 is at its lowest level since the pandemic began
The S&P 500 Index (SPX) has been extremely calm lately as stocks carve up. This has caused the benchmark’s historic 20-day volatility (HV) to plummet, which is at its lowest level since the Covid-19 pandemic began. This week, I’ll be analyzing how stocks have performed after those dormant periods.
Immerse yourself in historical volatility classes
First, I’ll look at how SPX stocks have performed in general, based on historical 20-day volatility that dates back to 1950. The table below summarizes the returns for the next month based on these parameters.
The most recent value of 7.4% from Tuesday’s closing price falls into the first category of lowest values. Unfortunately, the next month’s average return on the SPX is the lowest in its category at 0.38%. And while the percentage is positive at 60%, that number doesn’t vary much between parentheses. Meanwhile, next month’s volatility, as measured by the standard deviation of returns, is also the lowest on this column. This makes sense given the low volatility environment in which this situation occurs.
I wanted to see if this trend continued when I looked at more recent data. The following table shows the same data, but this time from 2010. The brackets are also slightly different, so everyone has the same number of readings. The SPX has performed best since 2010 after high levels of 20-day volatility. The one month returns are strongest in these two lower rows, where the value is 13.6% or more. The low volatility category shows a one month return of 0.49% which is the second worst category in the table. It seems that these low levels have generally resulted in boring underperformance.
Why volatility might stay low in the future
Since the volatility on the SPX is falling so quickly and some days with higher volatility will soon drop off the rolling 20 days, I predict that the historical 20-day volatility will soon drop below 5%. The table below shows how the SPX performed after these events, which have occurred 14 times since 1950. The data suggests strong returns in the short term, with the index gaining an average of 1.72% over the next month with over 85% positive returns. The SPX has typically gained 0.74% over this period, with a 62% chance of a positive return.
In addition, however, these signals show returns that are below the market. Six months after a signal, the average return and positive percentage are lower than what the market normally did. Based on these 14 events, volatility is expected to remain low.
For the curious, the table below shows each of the signals in the above data. The last signal came at the end of 2019, a few months before the outbreak of the Covid 19 pandemic. This resulted in a loss after six months as the SPX was in the early stages of recovery from the initial collapse. In the signal before that, from September 2016, stocks behaved in exactly the opposite way as expected after these signals. The SPX fell 1.35% the next month but rose nearly 13% the following year.