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A Dearth of Volatility Kicked off the New Year

With the first quarter complete, will volatility stay muted or ramp higher?


With the first quarter of 2012 now concluded, market pundits will be slicing and dicing a bevy of data to see how the last three months stack up versus quarters of days past. From a volatility perspective, we could certainly say the calm waters of Q1 2012 stand in stark contrast to the turbulent swings that plagued the market throughout the back half of 2011. Recently the Wall Street Journal chimed in and added color to the comparison:

“During the first quarter the Standard & Poor’s 500-stock index closed up or down more than 1% just seven times. It didn’t have a single session with a move of more than 2%. In contrast, the fourth quarter of 2011 saw 36 days with 1% moves and 14 sessions with 2% or greater moves.”

The question of the day tickling investors’ curiosity is what implications, if any, the current volatility drought holds for the second quarter of 2012 and beyond. Is the ebb in volatility here to stay or is a repeat of the volatility bonanza of 2011 looming on the horizon? Obviously time will tell, but I suspect it’s more of the former than the latter.VIX chart
Click to Enlarge

Though every bull market inevitably encounters the occasional correction, the severity of the volatility during the swoon that played out in the fourth quarter of 2011 was atypical. It will take some serious shocks to the financial system to resurrect the volatility beast that haunted the markets last year.

The more likely scenario is a continuation of the current low-volatility regime. Though we will eventually see a correction or two this year, it will likely be much more benign with notably less volatility than last year.

Two factors worth keeping an eye on that provide clues into the behavior of the CBOE Market Volatility Index (CBOE:VIX) are the price trend of the SPDR S&P 500 ETF (NYSE:SPY) and its historical volatility. Provided the uptrend in the SPY remains intact ,I see little reason in making overly bullish prognostications on the VIX.

In addition, until actual market volatility (as measured by 10- or 21-day historical volatility) begins to head higher — both are currently at 10% — the VIX will likely remain submerged below its long-term average of 20.

At the time of this writing Tyler Craig owned short positions on the VIX via a related ETN the VXX.

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