Volatility: The Price of Normalizing

Written by: Global Thought Leadership | January 18, 2019

Chart Courtesy of ClearBridge Investments. Source: Bloomberg. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line

  • Concerns about rates and earnings have played a significant part in the two major downdrafts in U.S. stocks that rattled investors last year.
  • But in 2019, stock volatility will likely be less driven by sentiment, than by the shrinking availability of liquidity to businesses and consumers.
  • Higher rates and the Fed’s program of quantitative tightening are obvious reasons, since they both make borrowing less attractive.  But the recent rise of the U.S. dollar, and widening of credit spreads1 also have an impact.
  • Indeed, ClearBridge Investments annual outlook notes a pattern of delayed impact between the fall of liquidity and the rise of volatility in the S&P 500.
  • Consider that liquidity can be measured by the term premium for bonds, i.e. the incremental yield the market demands for the additional time waiting to get repaid. One convenient measure of this is the flatness of the U.S. Treasury yield curve between 2 and 10 years.
  • ClearBridge’s chart suggests that as the 2- to 10-year spread falls, especially as it goes negative, volatility follows in lagged fashion – signaling the prospect of greater volatility in roughly 18 to 30 months.
  • As a result, it’s reasonable to expect that future gains in equity markets would be driven by earnings, political developments and valuations.

All data Source: Bloomberg  and ClearBridge Investments, unless otherwise noted.

1A credit spread is the difference in yield between two different types of fixed income securities with similar maturities, where the spread is due to a difference in creditworthiness.



Spread is the difference in yield between two different types of fixed income securities with similar maturities; usually between a Treasury or sovereign security and a non-Treasury or non-sovereign security.

Liquidity refers to the degree to which an asset or security can be bought or sold in the market without affecting the asset's price.

A basis point (bps) is one one-hundredth of one percent (1/100% or 0.01%).

The Federal Reserve Board (“Fed”) is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices.






IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

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