Record Low Volatility Across Asset Classes Because Of Globalization?Rupert Hargreaves
Explaining the lo vix can be a challenging task. Just ask Daniel Fenn, HSBC’s Multi-Asset Quantitative Strategist. He looks at the current geopolitical environment, with risk seemingly apparent at every corner, and wonders aloud why volatility is so low? But it is not just obvious factors such as increasing tensions both home and abroad that are challenging analysts. Even correlation relationships between implied and realized volatility are vexing. In a September 25 report, “The Bonfire of the Volatilities: Why is volatility so low?” HSBC addresses the question on so many investor minds.
It’s not just the stock market where volatility is knuckle-dragging near historic lows. On the heels of Goldman Sachs predicting that low stock volatility can last another year, HSBC notes the expansive nature of the dead calm. “Low volatility isn’t simply confined to equity markets, the report noted, pointing to “a truly global and also cross-asset phenomenon.”
The new HSBC Cross Asset Volatility Indicator shows that volatility is near lows in nearly all assets, with the stock market clearly leading the way. The HSBC Cross-Asset Volatility Indicator is approaching the 5th percentile low ranking, an area that was pierced in 2007 just before the global financial crisis and then again in 2014-2015, just prior to the August 2015 market crash.
To provide context for the dead calm, Fenn and a team of HSBC researchers note that there have been only five periods during the past 18 years when volatility was this low for a prolonged period. At the end of each period of strangely low volatility was one consistency: the bubble burst.
“These periods varied in length from 4 to 22 months, and were ultimately ended by events ranging from the bursting of the dot-com bubble to an oil-price collapse,” the report noted. HSBC had previously predicted the low volatility environment will end in a crash.
It isn’t just low vix that is odd.
The correlation between realized and implied volatility is breaking apart to various degrees. “Even if there is a spike in option implied volatility, this isn’t always met with an increase in realized market volatility,” Fenn and his team noted, pointing to August, when the low VIX shot higher in price twice but the trend lower in realized volatility “was barely interrupted.”
HSBC cites the usual suspects of why volatility is so low – “unconventional actions of central banks and the structural shift of investors away from active to more passive funds” – but “that can’t be the full story.”
HSBC acknowledges central bank actions and passive funds have “no doubt played a role in suppressing volatility,” as the suppression of interest rates through direct bond buying has created a global reach for yield. But this global reach for yield is not the only issue. There is a wider globalization effect.
“Global growth has become more synchronized, which is a “key driver” for the relatively stable economic climate. “Global growth has been incredibly synchronized of late, with all regions picking up at the same time.” Dispersion of GDP growth rates has declined, as the world economy moves in sync as “the volatility of economic surprises” has declined.
Surprises have not been seen to the upside regarding inflation, with tame inflation occurring during a period of generally steady growth, which flows into earnings. “This mix of steady growth and benign inflation appears to have filtered through into corporate earnings where, for the first time in many years, forecasts have held up,” the report noted.
When examining the panoply of potential causation for low volatility, one factor doesn’t clearly dominate. Central banks, passive investing, low inflation and strong earnings amid economic globalization is creating a pleasant mix of factors that are leading to low volatility. The question volatility traders are trying to answer is: when does this tranquility bubble burst?
Even with a record Low Vix both short and long products are hot with investors.
Volatility-linked investments are getting significant interest on both the long and short side, a Bank of America Merrill Lynch report noted. The increased activity comes as short volatility inverse VIX ETPs continue to experience positive performance. But the increase in long volatility VIX ETPs comes at a time when “the expectation that today’s quiet will not persist through the catalyst-rich fall” is on investor minds.
Long volatility VIX ETPs grow significantly as do short volatility investments
Long volatility VIX ETP positioning is up 50% month to date, the September 19 BofA Global Equity Volatility Insights noted.
The sudden surge in investors buying insurance as volatility premiums drop can be seen in the open interest in levered-long VIX ETPs. The double-leveraged TVIX and UVXY, for instance, has more than doubled since mid-August, the report noting, standing at a stout $150mn vega, which is up 50% month-to-date.
The moves to the long side of volatility come as a “catalyst-rich” period of time includes geopolitical tensions coming out of the Korean Peninsula but also ever-present dangers in the Middle East could inflame markets are any moment.
Here in the US, market watchers are focused on many domestic issues, including further interest rate hikes by the US Federal Reserve and tax reform, two of the more immediate issues that could come into play before years’ end. With valuations stretched, and market watchers noting that earnings results are increasingly being harshly punished for even the mildest of misses, even the slightest curve ball from left field could send stocks into a tailspin.
While some long volatility investors see risk on the horizon, this hasn’t stopped short volatility players from continuing to spin the roulette wheel.
As of mid-September 2017, there are 22 U.S. VIX-tracking ETPs with $5.2 billion in assets, a Morningstar report noted. The two most popular, ranked by open interest, are the SVXY and XIV, both inverse ETPs.
Interest in short volatility inverse VIX ETPs has increased month to date in September, moving to $225mn vega, which BofA noted was a fresh all-time high. Open interest had been hovering on both sides of -100 for the inverse VIX ETPs for the last three years.
Investors playing this particular parlor game have seen their investments grow in dramatic fashion. Since the start of 2017, the XIV, an inverse VIX ETF, for instance, has almost doubled. If an investor found the most recent bottom starting March 1, 2016, when the net asset value was at 18.90, that investment would be almost five times as valuable today.
The XIV works by taking advantage of the convexity of the VIX futures curve. Because there is a significant risk premium in volatility insurance, the VIX futures experience significant price deterioration 30 to 45 days before they expire. It is the deterioration of this front-month that is in large part driving the performance of the inverse VIX products.
Morningstar’s Adam McCullough noted inverse VIX-tracking ETPs profit from the volatility premium, but VIX ETPs are much riskier and their returns are much more correlated to equity market returns because they track the VIX futures curve and reset their exposure daily.
But problems can occur when the stock market crashes, as the front-month contract has a history of increasing by more than double that of the next back month. For instance, on August 10 when the S&P 500 was down a sharp 35 points, professional volatility trader Matt Thompson noted that the front month VIX futures contract increased in by 38%, while the next month out was only up by near 16%, with the third-month contract only up by 8%. “The back months are pricing in mean reversion,” the head trader at Dynamic Volatility noted. His CTA strategy trades the VIX using various stages of contango and backwardation to provide clues as to market opportunity.
Bank of America, for its part, notes that the outstanding vega of both levered and inverse VIX ETPs has growing to a “staggering” $375 million vega, an all-time high as well. “A volatility spike would cause both sets of ETPs to trade in the same direction in order to reset their leverage,” the report noted. “While this is a historically large amount of vega to trade, we reiterate our view that a short cover in the VIX space is unlikely to trigger an outsized move in equities.”
As low vix persists Goldman recommends buying high yield. Published on: Jul 6, 2017 @ 09:46
Only a day after Goldman Sachs’ analysts published a report noting that the current low volatility environment is unlikely to come to an end until a Black Swan event hits the markets, today another group of the investment bank’s analysts published a report claiming “as long as the level of growth remains strong, we think the low vol period and the gradual grind higher for equities are likely to continue.”
The report goes on to consider the best assets to hold in a prolonged low vix environment.
High Yield Is The Best Asset For Low VIX Environment
Historically, overweight equity and underweight government bonds has been the best performing combination. However, “the big difference now relative to history is that low rates have led to most assets being expensive, which will constrain returns across asset classes, in our view.” With interest rates rising, equities are unlikely to suffer, as long as growth remains strong, but the same is unlikely to be true for fixed income. Once again, historically low vol periods have seen positive returns for government bonds as coupon income has offset any capital losses from rising rates, but this has been different this time given much less coupon income. The one area of the market that still looks attractive to Goldman’s analysts is high yield where the carry still looks attractive. The longer the low vol cycle, “the more likely it probably is that spreads gradually grind tighter.”
High yield then is Goldman’s pick to outperform against the low vol backdrop. Interestingly, the outperformance of US high yield credit compared with other asset classes is not unique to low vol periods. Based on data going back to 1991 Goldman notes, “80% of the time US HY credit has better risk-adjusted returns than the S&P 500, and they are 4 times as large on average.” The report continues, “the difference in risk-adjusted returns is primarily due to the materially lower volatility of US HY - it generally has vol significantly lower than even US Treasuries. This tends to be driven by the negative correlation between credit spreads and risk-free rates as we are considering total returns.”
Traders are betting that the low VIX will not persist for much longer. Last updated Jul 5, 2017 @ 09:46.
After an extended period of low volatility, investors are beginning to position for higher volatility, that’s according to a new research note from Goldman Sachs published at the beginning of this week. The report, penned by Goldman’s economic’s research team headed by Christian Mueller-Glissmann, CFA, notes that during the past few weeks investors have begun to aggressively position for higher S&P 500 volatility. Demand for VIX calls has increased sharply. Meanwhile, inflows into the largest long VIX ETP (iPath S&P 500 ST future, VXX) have picked up and the net short on VIX futures has decreased. The VIX call/put ratio has spiked to one of the highest levels since the great financial crisis. All of these developments point to one conclusion; investors are positioning for more volatility and a higher VIX.
But are traders likely to be rewarded any time soon?
Traders Being To Bet That low vix Will Soon End
Goldman’s report notes that while volatility has picked up in recent days thanks to hawkish comments from central banks around the world and geopolitical concerns, bouts of low volatility can last for extended periods and there’s no telling when the current low vix regime will
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