Last Year’s Volatility is Setting up a 20% Rally

We just finished an incredibly volatile year… even if the standard volatility measure didn’t show it.

Most folks look to the Chicago Board Options Exchange Volatility Index (“VIX”) to see how much stocks are moving. And this so-called “fear gauge” tends to spike when the market is in turmoil.

Stocks suffered plenty of turbulence last year. But the VIX, while elevated much of the year, never exploded higher. In fact, the index’s 2021 high was actually higher than 2022’s… And of course, last year’s peak was nowhere near what we saw in 2020.

There are other ways to measure volatility, though. One of them says 2022 was one of the most volatile years since 1950.

That isn’t bad news. For us, it’s the opposite… It tells us a multiyear rally could be on the way.

Let me explain…

The VIX looks at the options market to see how much volatility traders expect over the next 30 days. The problem is, those expectations are often wrong.

So instead of using the VIX to measure stocks’ movements, we can simply look at the market itself.

Specifically, we can look at the number of big daily declines. The more declines we see, the more volatile the market is. In this case, I looked at the number of times stocks fell 2% or more in a single day.

By that measure, 2022 was a rough year. We saw 23 of those 2%-plus declines in the S&P 500 Index. And as the chart below shows, that’s one of the most volatile readings we’ve seen in more than seven decades…

Most folks might glance at the VIX and think 2022 wasn’t such a choppy year. But a different story emerges when you look at the market’s daily moves.

Last year was painful for investors. Stomaching 2%-plus down days over and over isn’t easy. And it might feel like this suffering has become the norm.

There’s good news, though… The years that follow this kind of volatility tend to be darn good for investors.

The table below shows this. It includes each year that had 20 or more 2%-plus down days in stocks – and the returns that followed…

Volatile years like these are rare. They happen less than 10% of the time. But they have a history of setting investors up for huge gains.

Stocks returned an average of 20% over the following year. And the average gain was 34% over the next two years. Those results are easily double the typical buy-and-hold return for stocks.

In short, extreme volatility hurts. But the pain doesn’t last forever. And history shows stocks have almost always outperformed after years like 2022.

That means that once the trend reverses, you want to get back into stocks in a big way.

Good investing,

Brett Eversole

Source: Daily Wealth