Equilibrium Markets in the Time of COVID
The pandemic snuck up on investors. On December 31, 2019, the government in Wuhan, China, confirmed that dozens of people were being treated for a new virus. China reported its first death from the virus on January 11, 2020, the World Health Organization declared a global emergency on January 30, and the first death outside China occurred in the Philippines on February 1. Financial markets took this news in stride. The UK’s FTSE 100 fell 1%, for example, from December 31, 2019, to February 20, 2020, and the S&P 500 rose 5% over the same interval. Things changed quickly, however, after that. Over the next month, stock indices around the world plunged, with both the S&P 500 and the FTSE 100 dropping by a third.
The behavior of the Cboe Volatility Index (VIX)—the index that measures the expected volatility of the S&P 500 index over the next 30 days—is particularly interesting. The index started 2020 at about 14, below its long run average of roughly 18.5, and it was still close to 14 on February 20. Then it exploded. The expected volatility of the S&P 500 rose by a factor of six in less than a month, to a high of over 85 on March 18.
Why did volatility go up so much? The short answer is, because there was so much to learn. This was a new virus that caused a new and potentially fatal disease. In early March, we did not know how contagious or lethal it was, who was most vulnerable, what one should do to avoid it, whether masks were an effective deterrent, or whether it would go away in the summer. Every day brought new information—some accurate, some not so accurate—that investors tried to interpret and project into the future. When the news was better than expected, prices would shoot up. And when it was worse than expected, prices would plummet.
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Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is registered as an investment adviser with the U.S. Securities and Exchange Commission (“SEC”) with its primary place of business in the state of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. References to registration with the SEC do not imply any endorsement or approval of the qualifications of the firm, nor do they imply that the firm’s representatives have attained a particular level of skill or training. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.
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