Low market volatility: should investors be concerned?

Published On : 07/22/2017

Tom Elliott, deVere Group

Stock market volatility has been low on most major stock markets this year. Furthermore, expectations of future volatility as measured through futures-based derivative contracts, are also low.

But does this indicate investor complacency, as many argue? If so, investors should perhaps sell and realise the 12.6% gain in USD terms made on global stock markets this year*. Or is it a sign of investor confidence?

The degree to which investors are expecting low volatility to persist is striking. The Nikkei Stock Average Volatility Index (Nikkei 225 VI), created in 2012 to help investors trade volatility on the Nikkei 225, currently stands at a record low of 2,297 (as of 18th July).

In Europe and the U.S similar low volatility is being blamed by market professionals for low trading volumes. The VIX index tracks expectations of future volatility on the S+P 500 index, as implied by derivative contracts. On 14th July, it reached a new multi-decade low of 9.52.

The complacency argument says that low volatility breeds investor complacency, and the more complacent we become the bigger the risks that we are prepared to take. Excess risk-taking then contributes to bigger market falls when panic sets in.

This argument applies to the economic cycle also. According to U.S economist Hyman Minsky, periods of stability in capitalism bread their own destruction through encouraging complacency. Banks over-lend to the wrong sort of customer, and investors put too much of their money into over-risky investments

But what do we do with such an insight? Is buying a risk asset – say, the newly issued 100 year Argentinean bond yielding 7.9% – an indication of complacency, or based in hard-nosed logic if we belief that Treasury bond yields are likely to remain low by historic standards for a considerable period time?

And isn’t warning of complacency to somewhat ignore the run of positive news flow we have seen since January, that has supported investor confidence?

President Trump did not impose a 40% import duty on Chinese goods upon taking office, and has not -so far- torn up any trade agreements. He has, though, taken the U.S out of TPP negotiations and picked squabbles with trading partners such as Mexico, Canada, and Germany, but the global trading environment remains broadly intact.

European voters rejected populism in the Dutch and French elections. In the U.K, Prime Minister Theresa May’s failure to secure her Conservative party an overall majority in the House of Commons was interpreted by many political commentators as an opportunity for a ‘soft Brexit’ to emerge from E.U negotiations, and so be less damaging to the economy than an abrupt ‘hard Brexit’.

The Chinese economy has not imploded under the weight of debt that it carries, or as a result of government policies to reduce borrowing. Second quarter GDP growth came in at 6.9%, above expectations.

While the Fed has raised interest rates twice this year, in line with predictions in January, yields on the U.S Treasury market and other global bond markets have risen by only modest amounts as inflation remains much weaker than would normally be justified by the low unemployment rate.

Indeed, the much-anticipated bond bear market appears to have been postponed indefinitely. Janet Yellen of the Fed recently speculated that the new ‘normal’ long term rate of interest may be just a percentage point higher than the current target rate of 1% – 1.25%.

Finally, global economic growth has been stronger than expected, helping to boost corporate earnings and to justify current stock market valuations.

In summary, it is too glib to accuse investors of complacency. Stock markets have had a relatively strong year, so far, because news flow has been better than expected. Steady gains, with no major sell-offs, result in low volatility. To be afraid simply because the market expects such conditions to persist, is perverse.

Uma Rajagopal

Uma Rajagopal has been managing the posting of content for multiple platforms since 2021, including Global Banking & Finance Review, Asset Digest, Biz Dispatch, Blockchain Tribune, Business Express, Brands Journal, Companies Digest, Economy Standard, Entrepreneur Tribune, Finance Digest, Fintech Herald, Global Islamic Finance Magazine, International Releases, Online World News, Luxury Adviser, Palmbay Herald, Startup Observer, Technology Dispatch, Trading Herald, and Wealth Tribune. Her role ensures that content is published accurately and efficiently across these diverse publications.