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Wednesday 20

February, 2019 4:51 PM



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Storm Clouds Ahead As Volatility Continues

Storm Clouds Ahead As Volatility Continues

By Expert Panel 04.02.2019


Are we in a new volatility regime?
 
As we start 2019, we inevitably see the regular ‘year in review’ and ‘year ahead’ commentaries. The tone of such conversations is different this year, and the exceptionally low volatility market on which commentators reflected in 2017 is no longer a topic of discussion.

Until the end of the third quarter of 2018, it appeared that the story of the year was going to be the continued divergence of US stock market performance from the rest of the world. This was driven in large part by FANG-heavy technology stocks, as well as the continued low volatility environment - despite a blip in volatility early in the year. But as stock market returns have showed us since the onset of 2018’s final quarter, cracks have emerged in the façade of FANG infallibility, and as a result, investors need to be prepared for a more volatile environment.

Back in 2017, and even through much of 2018, the CBOE Volatility Index (VIX) - known as the market’s ‘fear gauge’ which captures expectations for future volatility based on prices in the options market - was a hot topic. Sometimes referred to as ‘picking up pennies in front of a steamroller’, the much-discussed ‘short-the-VIX’ trade netted some investors enormous returns.

But this trade blew up with the first onset of higher volatility in 2018. This forced the closure of many of the Exchange Traded Products which allow retail investors to access this trade, after the products were nearly wiped out overnight. Out of the public eye, many institutional investors, including hedge-funds, were also hit hard in the futures markets.

What led to this exceptionally low volatility throughout 2017 and much of 2018, despite heightened political uncertainty and stretched valuations? The economy was performing strongly, risk assets were still supported by monetary policy, and corporate profitability was high on the back of tax cuts - in short, all of these conditions supported equity markets. But strong performance in equity markets doesn’t necessarily mean low volatility. In fact, these conditions were in place going back much further than 2017, and most bull markets saw volatility rise to much higher levels. Here is where the stories of low volatility and the narrowing performance of US markets converge.

In its year-end commentary for 2017, index provider S&P Global pointed to ‘record low correlations’ between index constituents, which ‘indeed may be seen as a causal factor’ for the low volatility environment. As such, while there were certainly a number of market-moving events over that period, market participants - and indeed, whole sectors - reacted in different ways, with some seeing gains and others losses. In this way, the big winners offset the weakest performers, which in aggregate resulted in dampened volatility.

Since October 2018, correlations have picked up as the technology stalwart FANG stocks led the broad market selloff, which in turn led volatility to spike. While interest-rate sensitive sectors have been struggling for much longer as financial conditions tightened, the upward trajectory of tech stocks is no longer enough to wash out the poor performers. December trading was also extremely volatile, with very large swings in markets over what is a usually tranquil holiday period. While the wild swings have receded at least temporarily, the elevated volatility looks here to stay.

Source: CBOE VIX, Eikon, January 2019

Perhaps most importantly, what does this regime change mean for how investors should now be positioned? With the return of volatility, broad market exposure earning attractive returns is unlikely to continue, and true active management will take on increasing importance to effectively navigate this environment. Overall, we appear to be facing a new volatility regime, and so we need to be highly selective with the risks we take.

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week's newsletter

Published by International investment experts, Fidelity

 
 
 
This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment. Investments in small and emerging markets can be more volatile than investments in developed markets.

This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider these matters before acting on the information.  You should also consider the relevant Product Disclosure Statements (“PDS”) for any Fidelity Australia product mentioned in this document before making any decision about whether to acquire the product. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading it from our website at www.fidelity.com.au. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise. 

© 2019 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited.


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