The stock market was narrowly mixed on Monday morning, as investors continued to wrestle with the ups and downs of earnings season while also factoring in the potential for conflict in the geopolitical and macroeconomic realms. As of 11:15 a.m. EST, the Dow Jones Industrial Average (DJINDICES: ^DJI) was down 32 points to 25,074. Broader market measures were generally higher, as the S&P 500 (SNPINDEX: ^GSPC) climbed 2 points to 2,710 and the Nasdaq Composite (NASDAQINDEX: ^IXIC) was up 14 points to 7,313.
It's only been a couple of months since the December swoon that took the S&P 500 to its worst levels since mid-2017. The abruptness of the move that sent the popular stock index down almost 20% from its highs came as a shock to many who'd enjoyed the bull market gains of the past 10 years. Yet since then, most measures of fear in the stock market have moderated quite a bit -- and investors seem almost too complacent as they dismiss the concerns that worried them so much toward the end of 2018.
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Volatility signals smooth sailing ahead
One way that investors look at expectations for turbulence in the financial markets is by using what's known as the Volatility Index, or VIX. This benchmark looks at the prices of options to determine how much up and down movement investors believe is in the cards in the near future, with higher readings indicating a greater likelihood of extreme moves while a lower reading indicates fewer abrupt movements for the stock market.
For context, the Volatility Index has spent much of the past several years in the teens, reflecting relatively low expectations for big market surges or crashes. Even after having seen some downward movement in the market earlier in the fall, the Volatility Index came into December well below 20. Yet by the last part of the month, readings of 30 to 35 were becoming commonplace as the Dow and other stock indexes plunged.
In January, that trend reversed itself. Stocks moved up, and volatility moved back downward into the mid-teens. That in turn has pushed many investors to get back into a risky trade that was highly lucrative for much of the early to mid-2010s.
Playing volatility with special investments
There are exchange-traded products that give you exposure to movements in the Volatility Index. The iPath S&P 500 VIX ST Futures ETN (NYSEMKT: VXX) sees its value go up when volatility levels rise, while shares in the ProShares Short VIX Short-Term Futures (NYSEMKT: SVXY) rise in value when volatility levels fall. As you'd expect, December was a good month for the iPath volatility investment, which saw its share price climb 36%. The ProShares fund, however, dropped 16% in December.
But with the market's recovery, the ProShares fund has reasserted its dominance. Shares of the fund are up 16% since the beginning of 2019, compared to a drop of 17% for the iPath investment.
When markets were generally moving higher in the early to mid-2010s, investments like the ProShares short volatility fund did extremely well. Between late 2011 and January 2018, shares of the fund soared 2,400%. Meanwhile, long volatility funds lost almost all of their value.
The problem, though, is that complacency can lead to catastrophic consequences. In just one day last February, the ProShares fund gave up almost all of its gains over the previous several years -- because volatility levels spiked higher abruptly. The spike actually led to the liquidation of a similar short volatility fund, exposing investors to complete losses.
Be careful with stocks
After a big drop, it's good to see the stock market regain lost ground. However, it's important not to become too complacent as an investor. Instead, be aware of risks but find opportunities whose potential rewards outweigh those risks. That way, you'll be prepared for whatever happens in the markets.
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