Low Volatility *Markets*

risk-dice-2It is now fairly well established (see here, for example) that low volatility stocks have, over the longer term, persistently delivered market-beating returns.  This finding applies to the U.S., to other developed countries and to emerging market countries. In essence, it appears that low volatility stocks are deemed boring and underappreciated but outperform because investors and money managers are busy looking for the big score.  To many, this concept is an anomaly in that it at least seemingly contradicts a basic premise of economics — that risk and reward are inherently connected.

However, as very serious practitioner is well aware, volatility and risk are hardly the same thing (see here and here, for example).  Even so, the data is clear that focusing on low volatility stocks, particularly during secular bear markets, can make great sense since these stocks tend to handle significant downdrafts better — see below, from Alliance Bernstein.

But I think that there is even more here than meets the eye. Take a look at the following comparison of the VIX and the S&P 500 from January, 1990 forward.Low Volatility Markets

Low and lowering volatility markets (like low volatility stocks) seem to correlate nicely to good results and provide a ready explanation for the current ongoing rally in equities. This concept deserves further scrutiny and ought to be watched carefully going forward.

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