2020 brought many new things to the investing world, including a pandemic to deal with. And with that, one of the most volatile stock market years in history.
Most other years have the stock market trading in locked steps. A typical combination of advancing markets and VIX (Volatility Index) calls for small advances during depressed VIX levels.
However 2020 stands out of the crowd so far. When compared with other volatile years (e.g., 2009 – Great Financial Crisis, 2000 – following the tech bubble) 2020 is on track for the 8th most volatile year ever. However, the main event, if we exclude the pandemic, is still ahead of us – the U.S. elections. Therefore, the chances are that 2020 still has room for an increase in volatility in the last months left until its end.
VIX and Stock Market Behavior
2020 also brought the fastest decline into a bear market in history. When major stock indexes (e.g., Dow Jones, S&P500, Nasdaq 100) dropped more than 20% from recent highs, it is said that a bear market started.
Well, this year, we witnessed the quickest such decline. But what followed was even more interesting. The market bounce was so strong that it marked the shortest bear market in history.
More precisely, the bounce from the lows quickly exceeded 20%, so we were back in a bull market in no time. Therefore, 2020 brought the quickest drop to a bear market ever, a bear market that turned out to be the shortest in history.
In market terms, that refers to volatility. More exactly, high volatility levels.
Uncertainty is the reason why volatility rises. Uncertainty leads to people (i.e., investors) placing all kinds of bets on various market reactions. Some panic easily and cannot stand a market correction of over 10% when their portfolio shows a 30% gain. So they sell – but forget that after paying capital gains taxes, they left with little or nothing while remaining uninvested in the long term.
Some other traders are speculators. They buy and sell here and there, using complex derivative strategies like futures and options to hedge against various market outcomes.
2020 so far brought Dow Jones daily swings of more than a thousand pips. They become a norm, especially in a declining market. As a rule of thumb, volatility increases when the market declines, as people panic easier on a declining than on a rising market. Therefore, VIX tends to decline in a rising market and rise on a declining one.
So far, 2020 is the 8th most volatile year ever. If we look back in time, there are some terrific events to consider when comparing volatility. But no year couples a pandemic with a U.S. election especially when one of the candidates is the unpredictable Donald Trump.
Traders, buckle your seatbelts. 2020 is far from over.