After the weekend's referendum on Crimea's rejoining Russia went much as expected, but without any huge escalation in the conflict, investors celebrated by sending the Dow Jones Industrials (DJINDICES:^DJI) up nearly 190 points, or 1.2%, as of 12:30 p.m. EDT. At the same time, the S&P 500 Volatility Index (VOLATILITYINDICES:^VIX), also known as the Fear Index, plunged more than 11%. Yet even though the fall in volatility represented a sigh of relief in avoiding immediate violent conflict, the big question is whether investors in the Dow and other stock indexes are being too optimistic about the eventual result of the situation.
Feeling the pain again
For those who invest directly in volatility, Monday's story has played out countless times. Following gains in anticipation of the key vote over the weekend, the iPath S&P VIX ST Futures ETN (NYSEMKT:VXX) gave back most of the ground it won late last week, with today's 4.5% drop erasing Friday's rise and about half of Thursday's gain as well. The VelocityShares Daily 2x VIX ST ETN (NASDAQ:TVIX) played out much the same way, with its double-leveraged strategy causing an almost 8% drop this morning.
The problem with volatility-based investments is that they're inherently short term in nature. Both the iPath and VelocityShares exchange-traded products focus on short-term futures contracts on volatility, meaning that they track investor sentiment about where the market is likely to head within the next month. By contrast, geopolitical events often take years to play out; so while specific key events might have a marked impact on the Fear Index from time to time, volatility measures won't always pick up gains in the longer-term perception of volatility.
Certainly, there's every indication that the situation in Ukraine is far from resolved. Even if Crimea peacefully becomes part of Russia, the next question is whether Russians in other areas of Ukraine will take similar measures to show their allegiance to their homeland. The resulting tensions could last for years, with the need for intervention from other areas of the world still a real possibility.
Being aware of the possibilities
Investors have to understand these longer-term ramifications in order to avoid getting caught up in short-term thinking. With the news cycle turning so rapidly, and with other hot spots such as China affecting your investments around the world, it's easy to forget entirely about a situation like the Russia-Ukraine conflict until the next escalation occurs.
The better choice for long-term investors, though, is to keep all these issues in the back of your mind. After all, other back-burner issues like the sovereign debt challenges of southern Europe haven't disappeared entirely, even though they've gotten a lot less volatile than they were a couple years ago. By remembering these events after they've fallen out of the headlines, you can do a lot to avoid getting blindsided by them the next time they make news