Calm before the correction
For a portfolio manager who focuses on equity volatility, it was interesting to watch how low volatility could go, and how long it could last, prior to February’s stock market selloff. In fact, realized volatility for 2017 (as measured by the annualized standard deviation of daily returns for the S&P 500® Index) was just 6.78%, the lowest reading since 1964. Moreover, the largest peak-to-trough decline experienced by the S&P 500® Index for the year was a loss of just 2.58% from March 1 through April 13. Implied volatility, as measured by the
CBOE Volatility Index® (the VIX®), averaged 11.09 in 2017, the lowest annual average in the history of the statistic, which began in 1990.
The VIX® also set new all-time records for an intra-day low, 8.56 on November 24, and a closing low, 9.14 on November 3. The VIX® averaged 10.31 for the fourth quarter, the lowest quarterly average over its 112-quarter history. Moving back into a more historical average range of 20 in February 2018, the VIX® spiked to a closing high of 38.8 on February 8 and bounced down to 19.59 on March 2.
Catalysts to consider
One catalyst for volatility we are watching closely in 2018 is US inflation. If it becomes a headwind for earnings, that could cause a market downturn. Geopolitical tensions remain a significant risk to market stability, as well. Global trade issues, Brexit negotiations, North Korea’s nuclear ambitions, unrest in the Middle East, and China’s growing influence are among a lengthy list of events that could shake global markets in the coming months.
A low-volatility approach to US equities
For 40 years, Gateway has focused on managing portfolios that aim to make it easier to stay invested for the long run by reducing the impact of severe equity market downturns, while still participating in equity market advances. Unlike traditional long-only equity strategies focused almost exclusively on investment returns, Gateway’s index option approach seeks to find an optimal balance between risk and return. We think that consistency is the key to long-term investment success and that generating cash flow with index option selling, rather than seeking to predict price fluctuations in securities, can be a reliable, less volatile way to participate in equity markets.
We invest in a stock portfolio that seeks performance similar to the S&P 500® Index, then sell index call options to create cash flow. Writing covered call options may effectively trade potential (unknown) upside in the equity markets for (known) call premium. We may also buy index put options in an effort to help cushion the portfolio against a severe market decline. Again, following a consistent process, regardless of prevailing market conditions, is critical.
At the end of the day, we do think that the US equity market is the most reliable source of attractive long-term returns, despite its high volatility relative to other asset classes and tendency to periodically deliver significant losses over shorter periods of time.
Michael T. Buckius, CFA®
Michael Buckius is Chief Investment Officer and a Senior Vice President of Gateway Investment Advisers, LLC. He is also a Portfolio Manager. In addition to portfolio management, his responsibilities include overseeing the firm's investment management and trading functions as well as product development and servicing individual client relationships.
Prior to joining Gateway in 1999, Mr. Buckius was an equity derivative sales professional at Bear Stearns & Co. and Bankers Trust Company, both in New York. Previously he held a variety of option-related research and trading positions at Alex. Brown & Sons Inc. in Baltimore.
Mr. Buckius received his BA and MBA in finance from Loyola University of Maryland and is a CFA® charterholder.