In their second-quarter (Q2) 2018 outlook, K2 Advisors’ Research and Portfolio Construction teams share their views on why investors should not fear the return of market volatility—and why it may unlock opportunities for active managers. We believe offering these insights will help investors better understand the rationale for owning retail mutual funds that invest in hedge strategies.

Don’t Fear the Fear Index

We suggested at the end of last year that when the massive tide of global liquidity injected into markets post-2008 begins to recede, a wave of volatility could follow. It appears as though the wave has arrived.

Market volatility—as measured by the VIX (the so-called “fear index”)—surged 80% in the first quarter of the year. The S&P 500 Index and Dow Jones Industrial Average both declined for the quarter respectively, while the Nasdaq Composite Index managed a modest gain based largely on its sharp rise in January. Nine out of 11 S&P 500 sectors traded lower.

The steepest declines were in telecommunication services, consumer staples, and energy. Information technology and consumer discretionary were positive outliers despite selling off broadly in March. The negative quarter for the S&P 500 Index broke a string of nine positive quarters, the longest streak in 20 years. In addition, all of this happened following the nine-year anniversary of the bull market, which began on March 9, 2009, and 10 years after the bailout of Bear Stearns.

So now what? From our perspective, a reversion from the unprecedented low levels of volatility was to be expected—perhaps even welcomed. In some ways it reflects the resumption of more normalized market behavior. This is a good thing, in our view.