Another October In The Books (And No Crisis)!

In fact, for one of the historically most volatile months, this October has seen record lows in the Volatility Index (VIX), now sitting just below 10. If you remember 2008, volatility set record highs (above 60 on the monthly chart above).

As we briefly discussed on our High Rock weekly video (formerly known as our weekly webinar), yesterday: Central banks do not like volatility because it erodes confidence, both at the business and consumer levels, and when they are not confident, businesses and consumers postpone making economic decisions, which in turn negatively impacts the economy.

So central banks pumped vast amounts of liquidity into the global financial system (by purchasing bonds from the bond market) after the financial crisis in an effort to combat the surge in volatility that followed.

It has worked. Consumers are the most confident they have been in years (certainly in the US, chart below):

Investors are extremely confident as well! Stock markets in the US are pushing record highs (gold line in the chart below):

Bond markets (the white line) are being held by continuing low inflation.

So that is all history.

Our job as risk, portfolio and wealth managers is not to dwell on on what recent history has provided us, but to look forward to try and find the potential risks that lay in wait somewhere down the road.

Looking at the 30 year chart of volatility index (back at the top), there is a pretty clear pattern that evolves over time: a swing from higher levels of volatility to lower levels and back again.

Suffice it to say, there is a pretty strong likelihood of this pattern repeating. Volatility rises when uncertainty rises, but for the moment, central banks have reduced the impact of uncertainty (of which there is no shortage, at the moment).

Volatility spikes come when new and previously unidentified shocks (economic and / or geo-political) surprise financial markets.

Our job is to be on guard for impact of those shocks. 

Having balance between equity (stock investments) and bond investments has historically proven to mitigate at least part of a spike in volatility. In 2008-2009 a 60% equity portfolio and 40% fixed income portfolio probably dropped about 15%, or thereabouts, before beginning its recovery.

At current levels, low yields on bonds and record high stock prices, that correlation no longer can offer the same protection (more on this here: https://www.bloomberg.com/news/articles/2017-10-30/pimco-quants-say-beware-of-bond-hedges-for-high-flying-stocks).

That is why (at High Rock) we advocate a more tactical approach to investing, because our duty to our clients (and our families, because we invest in the same assets as our clients) is to try to protect them, as best we can, from the ravages of volatility, which are not only potentially financially devastating, but also psychologically devastating as well.

Being defensive means that you won't likely get the double digit growth that stock markets offer when they are making record highs (although High Rock clients may notice that October added nicely to their portfolio growth). However, it also limits the potential downside, which, over longer periods of time, allows a more even and predictable growth pattern.

That is the stewardship of wealth rather than the "rolling of the dice".