These 4 S&P 500 stocks are helping to tame U.S. market volatility

MW These 4 S&P 500 stocks are helping to tame U.S. market volatility

By Mark Hulbert

Stocks not only can gain with the VIX at such extreme lows - they usually do

Far from being a source of concern, the U.S. stock market's extremely low volatility is something to celebrate. The CBOE Volatility Index VIX, or VIX, which is a measure of the S&P 500's SPX expected volatility over the subsequent month, is now lower than 88% of daily readings since 1990.

Contrarians see such an extremely low volatility as a warning - a sign of dangerous complacency in the market. Their concern is misplaced, as I discussed in a column in late March. In fact, the U.S. stock market produces better risk-adjusted returns when the VIX is low than when it is high.

The past three months are a good example: The VIX was at the 18th percentile when that March column appeared, and the stock market has since performed well.

No single stock is responsible for the VIX being so low. That's by design, since the VIX focuses on volatility of the S&P 500 as a whole, which is a function of the interactions between each of the 500 stocks. But several of the largest-cap stocks in the index have definitely played an outsized role in reducing the VIX. Among the largest holdings in the S&P 500, four have one-year betas of less than 1.0 - which means they rise less than the market when the market rises, and fall less when it falls. These four, along with their betas courtesy of FactSet, are:

Berkshire Hathaway BRK.A BRK.B: one-year beta 0.55Eli Lilly LLY: 0.59JP Morgan Chase JPM: 0.69ExxonMobil XOM: 0.24

Academic credit for documenting that the market does better when the VIX is lower goes to Alan Moreira of the University of Rochester and Tyler Muir of UCLA. In their study, which appeared in the Journal of Finance, they devised a market timing model to exploit their discovery. Their core idea is to mechanically increase or decrease your equity exposure level as the VIX falls or rises.

Though the professors' model is more complex, a simplified version has just two steps:

Pick the "neutral" VIX level that will correspond to your portfolio's target equity exposure level.To determine your equity exposure in any given month, multiply your target weight by the ratio of the neutral VIX level to the VIX's close of the immediately prior month

To illustrate, let's assume your neutral VIX level will be equal to its historical median of 17.65, and that your target equity weight is 60%. The VIX finished May at 12.92, so your equity exposure level for June would be 60% times the ratio of 17.65/12.92 - or 82%. In backtesting to 1990, this simplified version of the professors' model performed 28% better than the S&P 500 on a risk-adjusted basis.

The VIX won't stay low forever. But the professors found that it doesn't pay to jump the gun. The time to reduce your equity exposure will be when the VIX does eventually rise.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: Hedging against a stock-market selloff has almost never been cheaper

Plus: Stocks' path to record highs is increasingly narrow. Why a selloff may be overdue.

-Mark Hulbert

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June 13, 2024 12:59 ET (16:59 GMT)

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