S&P 500 volatility close to 43-year lows as uncertainty rises

S&P 500 volatility close to 43-year lows as uncertainty rises
on November 2, 2016

Something very strange is happening in US stock markets, as the above chart highlights:

  It shows weekly (blue line) and average quarterly (red line) volatility in the US S&P 500 Index since 1928
  Both are very close to 43-year lows, going back to September 1973, at 1.7% and 1.6% respectively

This seems quite extraordinary, given the volatility seen in other financial markets, and rising political uncertainty:

  Interest rates have been rising rapidly: the US 10 year Treasury rate is up by a third since July to 1.8%
  The US Presidential election is clearly one of the most bitterly fought in decades
  Globalisation appears to have stalled: the EU-Canada deal only just managed to gain approval last week
  And, of course, there are growing concerns about what will happen when the UK triggers Brexit negotiations in Q1

There are a number of potential explanations for the lack of volatility.

One is that traders have become used to taking direction from the US Federal Reserve.  As the Fed is clearly on hold at the moment, waiting for the outcome of the Presidential election, traders have nothing to guide them and so are unwilling to take a position.  If the market moves up a few points, they therefore sell off – and vice versa.

A second is that markets are perfectly priced, with all possible uncertainties balancing each other out, and there is no justification for anyone to try and push the market higher or lower.

A third could be that markets are moving back to the lower volatility levels that were common before 1973.  Certainly, financial flows have been reducing.  Regulators have demanded that the banks hold much higher levels of reserves to back their trading activity – making this less attractive for them, by reducing their ability to leverage their bets.

A fourth could be that traders are simply terrified of making a mistake this close to the end of the year.  Players have nothing much to gain, and a lot to lose, given that they are only weeks away from receiving their annual bonus.

Probably all of these explanations contain some element of truth.  And it is also true that it is generally more profitable to follow the trend, rather than to be a “hero” or “heroine” by placing large bets on an essentially unknowable outcome.

The latest IeC Boom/gloom Index above confirms the sense of uncertainty.

The Index is trading within the 4 – 6 band, where the Fed has previously moved in to support prices with new stimulus. It therefore suggests a fifth possibility, that markets could be very vulnerable if such support does not appear.  The start of the Great Reckoning may perhaps not be very far away.

Share This Post
Leave A Reply