There have been several significant surprises in capital markets so far in 2017, which investors should take into account when making portfolio decisions.
These include 10-year US Treasury yields plummeting back to late 2016 levels despite analysts predicting they would rise amid interest rate hikes; the price of bitcoin surging to record highs despite the Securities and Exchange Commission rejecting the launch of a new bitcoin ETF; and perhaps most surprising, is the current record low levels of volatility in US markets. And investors show little signs of hedging against a turnaround.
Calm backdrop shows no sign of reversing
Thanks to the improving global economy, robust corporate profits and plenty of central bank stimulus, volatility is low across certain equities, fixed income, currency and commodities around the world, in whichever way investors choose to measure it.
The most common barometer is the CBOE VIX Index, which is below 10 points, the lowest level since 2006 and at a lower level than the vast majority of all its closing prices in almost two decades.
The makers of the index say the VIX Index cannot fall to zero, but this has not stopped speculation that it might. It could also spike – it was almost at 90 during the height of the last credit crash.
Looking at the volatility of the S&P 500 Index, investors were expecting at least 19 days of moves of at least 1% according to historical norms. Year to date, however, the S&P 500 has only moved more than 1% in a three-day span. Volatility, as shown below, has crept downward since 1 January, halving from around 12% to just 6% today.
On US markets there are 19 listed exchange traded products that track volatility. Most of them are short or leveraged, which makes them only suitable for professional investors. Yet the largest fund in the category is long-only and has attracted new capital.
The iPath S&P 500 VIX Short-Term Futures ETN (VXX) has $820 million in assets and replicates an index of future contracts on the VIX that expire on average within one month. Negative performance in the asset class is evident by looking at the S&P 500 VIX Futures Enhanced Roll Total Return Index – USD, below, using TrackInsight data. The volatility of that index has mostly tracked sideways since 1 January.
The fund is down more than 45% year to date in USD terms, and has lost around 77% in the past year. But this has not deterred investors, who have placed around $163 million into the ETN in 2017 alone, ETF.com data found.
The allocation of fresh capital has prompted analysts to comment that investors are gearing up for increased volatility in the near future, and are expecting a pull-back in stocks. That does not mean a meltdown is imminent, but that low volatility tends not to last forever.