This website uses cookies to collect usage information in order to offer a better browsing experience. By browsing this site or by clicking on the "ACCEPT COOKIES" button you accept our Cookie Policy.

As Volatility Fades, Can Cyclicals Shine?


Visit: BlackRock



Russ explains why he expects volatility to drop – and cyclicals outperform.

Despite a stellar 2020, market momentum did not survive January. After a strong start, stocks surrendered gains as investors tried to process triple digit volatility in a handful of small-cap, heavily shorted names.

While the damage to markets was minimal, the boost to volatility was not. Even after fading from the late January peak, the VIX Index ended the month 45% above where it started. That jump represents the largest month-over-month increase since the fall of 2018.

While volatility has started to fade, the VIX Index and other measures of equity volatility remain well above their long-term average. Technical dislocations may continue to cause short-term disruptions, but two factors favor a further drop in equity volatility: an improving economy and exceptionally easy monetary conditions.

Starting with the economy, while a few economic indicators have softened there is ample evidence that the economy continues to improve. Economic surprise indexes remain solidly in positive territory, suggesting most economic data is beating expectations. With the vaccine rollout accelerating and more stimulus on the way, I would expect further improvement.

The second factor favoring lower volatility is easy money. Regardless of the precise metric – credit spreads, money supply growth, real interest rates – money has rarely been this cheap or available. This combination of an improving economy and favorable financial conditions typically coincides with low volatility.

For example, a simple one-factor model using credit spreads as a proxy for financial conditions explains about 55% of the variation in the VIX Index (see Chart 1). Based on this relationship, volatility is still way too high. As credit markets proved resilient during the recent sell-off, high yield spreads remain tight. Narrow spreads suggest the VIX should be trading closer to 15 than 25. Looking at different measures and combinations of factors leads to a similar conclusion: Equity volatility has further to fall. 

High yield spreads vs VIX Index 1994 to present

Lower Volatility = Cyclicals > Defensives

Easy money and an improving economy suggest not only lower volatility but further equity gains. That said, those gains are not likely to be shared equally.

Assuming volatility continues to grind lower, history suggests favoring cyclical over defensive stocks. Based on 20 years of data, when the VIX is falling the MSCI Cyclical – Defensive Return Spread Index posts an average monthly gain of around 1%. When the drop in volatility is large, 10% or more, average cyclical outperformance expands to nearly 2%.

Given this dynamic I would continue to favor cyclical expressions including machinery, specialty chemicals, and cyclical parts of technology. At the same time, I would remain underweight the more overpriced parts of consumer staples, particularly household and food products. For investors, the conclusion is not just to maintain equity exposure, but to favor those parts of the market most likely to benefit from a normalization of both the economy and (hopefully) financial markets.

Russ Koesterich CFA, JD, is a portfolio manager for BlackRock’s Global Allocation Fund as well as the lead portfolio manager on the GA Selects model portfolio strategies.

Originally Posted on February 17, 2021 – As Volatility Fades, Can Cyclicals Shine?

© 2021 BlackRock, Inc. All rights reserved.

Investing involves risk, including possible loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 2021 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

©2021 BlackRock, Inc. All rights reserved. BLACKROCK is a trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.


Disclosure: BlackRock

©2020 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from BlackRock and is being posted with permission from BlackRock. The views expressed in this material are solely those of the author and/or BlackRock and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Disclosure: Margin Trading

Trading on margin is only for sophisticated investors with high risk tolerance. You may lose more than your initial investment.

For additional information regarding margin loan rates, see

Disclosure: Futures Trading

Futures are not suitable for all investors. The amount you may lose may be greater than your initial investment. Before trading futures, please read the CFTC Risk Disclosure. A copy and additional information are available at

trading top