US Volatility: When Will You Return To The Market?

US market volatilityUS market volatility

Volatility is necessary in trading. Although no-one misses the volatility of 2007 and 2008, when the models used by banks and funds simply no longer had any value, this factor is needed to make markets. And if the market falls, what do traders do?

Neither John Stuart Mill, Adam Smith, nor the Black-Scholes formula can answer this, but rather evolutionary biology: find a date. On July 11, the revered and influential financial news agency, Bloomberg, talked about “a head of trading” at a bank who said he spent his downtime at work on Tinder, the famous app which helps with dating. His aim was not to find a stable relationship, but rather something fast, like a one-night stand. While the algorythms are busy with High Frequency Trading, the human being is left with High Frequency Dating.

The case of the womanising head trader was not an isolated one. One of his competitors in another financial institution used his hours on the trading floor to prepare a golfing holiday. The cliche: “buy!, sell!”, etc, full of coarse interjections which have characterised the financial world in Hollywood seems to have disappeared.

Unknown factors

Why has volatility disappeared? In theory, there are more than enough reasons for the market to be nervous. The president of the world’s biggest power is being investigated for possible collusion with the Russian government in the elections which took him to power; his economic agenda is completely paralysed.

And North Korea is testing strategic ballistic missiles and could have the hydrogen bomb; the biggest financial centre in the world, London, is facing an uncertain future; the state of China’s financial system remains a mystery, and that country is annexing an area of the ocean which is five-times the size of Spain. And, finally, all the tensions and terrorist threats are as active as they were a year ago.

It’s true that for the first time in a decade the world is growing at a sustainable, but discreet, pace, and the EU’s prospects have radically improved. But it’s also true that the central banks – at least the Fed and the ECB – have already expressed their intention of reducing the liquidity in the market and selling part of the debt they accumulated during the crisis. But if this operation is not carried out with care, it could distort the market. It’s still surprising that nobody is frightened by this. Or that no-one is capable of taking advantage of it to obtain extra returns.

Many, like JP Morgan’s Marko Kolanovic, attribute it to the fact there is a proliferation of listed funds and investment strategies which are based, precisely, on betting against the VIX. According to this thesis, passive investment strategies are increasingly more popular. This means that whole sectors rise or fall in tandem with the indices in which they are included. Some estimates flag that 60% of shares in the US market are in portfolios which are managed passively or via computer programmes. Only 10% are in the hands of ‘stock pickers’, namely people who buy and sell shares the old-fashioned way.

Others are of the opinion that, with inflation running below minimum levels across the globe, almost unlimited liquidity, sustained growth and the banks, in general, healthy – as long as you don’t look too closely at countries like Italy – it’s logical that the VIX is very low. In fact, volatility has dropped throughout the world. And this could definitely be a sign of stability, but also of the calm before the storm. It reminds the more pessimistic amongst us of 2007. The only time the VIX was as low as now was in December 1993, scarcely three months before the Federal Reserve began to raise interest rates, the bond market tumbled  and Mexico suffered the tequila crisis.

About the Author

Pablo Pardo
Pablo Pardo is Washington DC correspondent of El Mundo. Journalist especialized in International Economics and Politics.