Volatility Returns in Historic Fashion

By the end of 1932, official unemployment had reached 25.2% and Real Gross Domestic Product (GDP), an indication of a country’s economic output to be distributed to citizens, had fallen by -12.9%. By comparison, the highest official unemployment rate during the 2008-2009 Financial Crisis was 9.9% and the loss to Real GDP was a fraction of that in 1932 at -0.29% in 2008 and -2.78% in 2009. On March 3, 1933, during his inaugural speech, President Franklin D. Roosevelt stated, “So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance.” It is with an understanding of that nameless, unreasoning, and potentially unjustified fear, that Watch Guard Capital (WGC) constructed a modern investing philosophy and developed hedged Dynamic Portfolios with Non-Emotional Quantitative Tactical Shift Signals (WGC Investment Primer, pp 13-14). This investing philosophy adopts the position that a wise strategy mitigates the possibility of investor paralysis by developing and employing contingency plans that allows for the acquisition of additional assets after known market selloffs. In doing so, volatility was incorporated into investors’ strategies to allow market “retreats” to become potential wealth “advances.”

The CBOE Volatility Index (VIX) is known as the “Fear Index” and gauges market uncertainty and the willingness of investors to purchase insurance against investments to reduce risk. The VIX averaged an annual volatility or “fear” level of 19.68 between 1990 and 2016. In 2017, the stock market was abnormally calm and the VIX had an average annual trading level of 11.09; not necessarily a positive condition for strategies that were built to adapt to increased volatility. In doing so, a new “no fear” risk environment was introduced and WGC models evolved accordingly. Specifically, a small exposure of an investment that increases in value if investor fear remains subdued was incorporated into models. The portfolio risk vs. return characteristics improved after modeling all the historic movements between 1990 to 2016 (6,565 observable daily movements). There were only ten days during the 6,565-day period that the VIX or fear jumped more than 40% in a single day with the highest recorded daily movement occurring on Tuesday, February 27, 2007, when it increased 64.22%. On Monday, February 5, 2018, the VIX or “Fear Index” set a new record when it increased 115.60% in a single day. WGC is constantly monitoring portfolio performance, has removed the low-VIX hedge, and welcomes a return to normal volatility conditions as we remind investors that with a proper plan, "the only thing we have to fear is fear itself.”

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