- Volatility went through the roof after “Liberation Day” as markets corrected sharply.
- Since then, volatility (as measured by the VIX Index) has come back down to earth rapidly.
- Historically, a quick return to calm waters has boded well for future stock market returns.
- The jump and retreat in volatility this time around differ from normal in that they were driven 100% by politics.
- Each historical episode is unique, and the common thread is that once volatility calms down, investors tend to prosper.
- Market gains are likely to come slower from here, but the resilience seen in economic data thus far this year suggests businesses and consumers are well positioned to deal with whatever comes next.
Four and a half months into 2025 and it has already been an extraordinary year, with investors living through enough drama to cover a full year or two at least! The most unique aspect to markets this year has been just how quickly stocks have recovered from a near-20% sell off for the S&P 500 and a significant spike in the “VIX” volatility index – also known as Wall Street’s “Fear Gauge”.
VIX has “settled” rather quickly…
We recently came across some research that looked at market history after the VIX reached 45 or higher as it did recently. This has happened 16 times since 1987. The next step was to see how long it took for the VIX to normalize after a large spike in the index, measured by looking at the value to day versus 50 days ago. When the VIX is lower today than 50 days ago, it is assumed that the dust has settled on whatever event caused the drama in markets.
…which historically has meant healthy returns
In all events going back to 1987, it typically takes about 2.2 months for things to normalize, yet this year it happened in 1.3 months, the fastest in the data set. While we see little correlation between how quickly things normalize and future returns, it is really the returns after the dust settles that we find exciting. Historically the S&P 500 has gained an average of 12% six months after volatility normalizes and 17% over 12 months, both well ahead of the long-term average returns seen in U.S. stocks. Interestingly the probability of a positive return is 71%, right in line with the full data set. Said another way, after volatility normalizes stocks have the same probability as they always do of producing a positive return, but the returns have typically been higher than average when they are positive.
Manufactured crisis solved?
Essentially all of the jump in volatility this year has been due to a material shift in U.S. trade policy, and as we have said before, manufactured crises are the easiest to solve. That certainly seems to be the case in the here and now, as one set of social media posts started the crisis, and series of others has brought stocks back where they were before this all began. We are as happy as anyone to see a steep recovery in portfolios but would be careful not to extrapolate the current pace of gains too far forward. It is becoming clear that the tariff level for the U.S. will be higher at the end of 2025 than it was at the beginning, though seemingly well below the levels rolled out on Liberation Day. It has yet to be seen what impact these new tariffs will have on economic or earnings growth, and further bumps in the road are inevitable. With that said economic data thus far in 2025 has surprised to the upside, suggesting a resilience on the part of businesses and consumers that puts them in a strong position to deal with whatever may come next.
The Harbour Group
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