Stock market volatility is likely to increase in 2016 compared to 2015, although it’s unlikely to remain around the levels seen in recent weeks.
That’s the view of Goldman Sachs’ Krag Gregory who expects a modest uplift in volatility this year based on the banks’ US economic growth, unemployment, core PCE inflation and Fed funds rate forecasts.
Gregory uses the VIX index, known by some as an “investor fear gauge” given it tends to spike during periods of severe market ructions, as the metric he’s based his call around.
The VIX is a forward-looking indicator that measures expectation for volatility in the US S&P 500 index over a 30-day outlook, using put and call option pricing to derive its overall level.
As volatility increases, so too does the price for options, leading to an increase in the index. The opposite occurs during times of low volatility.
Gregory expects that the VIX will average 19 over the course of 2016, with monthly averages ranging from 18-21. This is 2.3 points higher than the 2015 average of 16.7.
The put that figure into perspective, the VIX currently sits at 23.95, having hit a high of 27.39 earlier this week. At 19, Gregory expects volatility will, on average, be lower than what has been seen in the early parts of 2016, something that many investors will welcome should his call be proven right.
The chart below, supplied by Gregory, reveals how his call compares to volatility levels in recent years. Notice the slight uptick in the VIX in 2015 from that seen in the prior two years, something that coincided with an end to quantitative easing from the US Federal Reserve.
Based on his analysis, Gregory suggests that a VIX reading in the high twenties to low thirties equates to “recession volatility”, with zero GDP growth in the US consistent with a VIX level of around 24-26.
Essentially, as economic growth slows, or contracts, the VIX tends to rise.
Based on Goldman’s view that the US economy will grow at a seasonally adjusted annual rate of 2.25% in in 2016, Gregory does not expect extended bouts of market volatility, hence a higher VIX, to last.
For options traders, or those simply looking to trade the actual VIX index, Gregory recommends selling VIX spikes into the high-twenties to low-thirties when the economy is on solid footing.
On the flipside, given his expectation that the index will average 19 in 2016, he also suggests that declines back to the low-teens may serve as volatility buying opportunities.
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