September 30, 2020

The Return of volatility


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volatility-102414By Ashley Kindergan From The Financialist

When it comes to transitional moments, few match the suspended-in-mid-air feeling on a roller coaster at the instant the car has reached the top of the first big hill and perches for a few seconds, hovering over the inevitable. Of course, there’s also investing in 2014. Financial markets have been hovering in a place a lot like that for the better part of a year, as ever-rising stock and bond markets led many to wonder just how long is too long for a bull market. And then it happened. In a single week – Oct. 8 to Oct. 15 – the S&P 500, Dow Jones Industrial Average, and Eurostoxx each fell some 5 percent, while U.S. Treasury bond yields fell from 2.35 percent to 2.15 percent as investors piled in for safety.
Most telling though, was what happened to the market’s measure of volatility, the VIX. It more than doubled, rising from 15.11 on Oct. 8 to 31.06 on Oct. 15, before falling back to 25.27. Anything above 30 is considered a sign of panic in the markets, but even the 25.27 level signified that traders believed the S&P could gyrate up to 7.2 percent over the course of the following month alone – up from 4.4 percent just a week earlier. The ride seemed to have begun in earnest.
Moves in risky assets have hinted at a broader upheaval for several months. While Credit Suisse’s leveraged loan index dropped 0.43 percent on Oct. 15, leaving it 3 percent off a July peak, it had already fallen 1.2 percent as early as Sept. 15. Similarly, the bank’s index of high-yield bonds, which yielded 4.71 percent in June, hit 5.5 percent in mid-September and 6.45 percent after Oct. 15.
The catalyst for the spike in volatility seems to have been a report that U.S. retail sales fell 0.3 percent in September. But as Credit Suisse strategists pointed out, the magnitude of moves across many different asset classes qualifies as a gross overreaction to a relatively minor data point. Put another way, then, the data was merely the icing on an already unappealing cake. The IMF, for example, had lowered its forecast for 2014 global growth to 3.3 percent on Oct. 7 due to weakness in the euro zone, Japan, and China. Markets have been particularly concerned about Europe, where even Germany saw exports and industrial production nosedive in August. And then there’s Ebola. “Compared to other [recent] bouts of serious risk aversion, it is more difficult to point to one factor driving the negative market dynamic,” the strategists wrote. “De-risking seems to be a dominant theme as funds look to… lock in what will likely be a mediocre 2014 for most market participants.”
But the markets regained their equanimity just as quickly as they panicked. The S&P has gained 4.6 percent, the Eurostoxx is up 3.4 percent, and U.S. Treasury yields have nudged slightly higher to 2.23 percent. The VIX closed at 17.87 on Oct. 21, a reflection of expectations that the S&P 500 could move 5.15 percent over the next 30 days, as opposed to the 4.25 percent expectation (based on the 2014 VIX average of 14.75) that has been normal for most of this year. In other words, though investors are expecting more turbulence than usual, market fears are still much more subdued than in the midst of the selloff. Still, it’s clear that the highly correlated risk-on, risk-off market environment of the financial crisis years is back. And for the time being, the tone is distinctly risk-off.
What’s in store? To answer that question, Credit Suisse Head of Global Macro Product Strategy Research Sean Shepley looked to the recent past, and examined how 10-year Treasury swap rates performed after the 2010 Flash Crash and a mid-2011 selloff linked to the European debt crisis. “In both cases,” he says, “high volatility and heavy losses for risky assets persisted and often extended further over the subsequent month.” Shepley expects a similar and sustained period of risk aversion in which investors favor the relative safety of the yen and the dollar, while fleeing the euro at the first sign of negative economic or inflation news. That explains why Treasury yields, which were expected to rise in 2014 as the Federal Reserve wound down quantitative easing, have been suppressed by fears of a triple-dip recession in Europe. And they could remain suppressed for some time: Credit Suisse lowered its expectations on 10-year yields from 3.2 percent by the end of the first quarter to 2.65 percent.
The de-risking sentiment that prompted investors to dump stocks, however, is likely to lose steam sooner, according to Credit Suisse Head of Flow Equity Derivatives Trading Khoa Le. “A lot of people were caught on the wrong side of market volatility, and the majority of flows we saw were essentially closing positions,” he said on a recent conference call. “Effectively, you had the buy-side community saying, ‘We’re out.’” If volatility spikes again soon, they’ll probably stay out. But if it remains subdued, they will likely feel pressure to come back in.
Clearly, markets are deeply uneasy. Credit Suisse economists point to weakness in Europe and Asia as areas of major concern – particularly Asia, which comprises 45 percent of the world’s industrial production. Still, Credit Suisse Chief Economist for the Investment Bank James Sweeney remains optimistic that after falling for three straight quarters, global growth will accelerate toward the end of the year, driven primarily by strength in the U.S. economy. Investors would be remiss, though, if they confuse any good news with the end of the roller coaster ride. That was just the first hill.
Photo by John Leung courtesy of
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