Schaeffer's Trading Floor Blog

Is Volatility Shifting?

Dissecting the day-to-day volatility in markets

by 3/6/2014 7:34 AM
Stocks quoted in this article:

Does it seem like there's always a bid under the market? Well yes, of course it does. I noted yesterday how we just condensed our whole international-crisis market cycle into two days … down from something like a few weeks not all that long ago.

The question is where does this perma-bid come from? The Bernanke (now Yellen) Put? Clearly, monetary policy can goose demand (at least that's what they taught us in college). But that explanation only goes so far; that's more a long-term driver than a day-to-day one.

Josh Brown has an interesting unifying theory on the subject. I can't do it justice in a couple of clipped paragraphs, but the gist is the shift of the consolidation of the financial services industry into a smaller number of gigantic firms, and an overall shift of the business from a transaction-based model to a fee-based model.

And he throws out this striking number.

In 2005, fee-based accounts directly managed by financial advisors and brokers totaled $198 billion. As of year-end 2013, that figure had soared to over $1.29 trillion -- more than a sextupling in under a decade. It is safe to say that, while some of these fee-based accounts are managed actively (brokers picking stocks, selling options and whatnot), the vast majority are not. Most of this money is being run more passively -- in the absence of a transactional commission incentive for the advisor to trade, why else would he? Edge? LOL.

Why does that make the bid permanent? Well, if the goal becomes more about long-run returns than short-run flips and commissions, it makes more sense to allocate more into stocks, and do it on a relatively passive basis.

He cites some more evidence of his theory.

For one, the lighter volume on the NYSE in recent years -- trades are only taking place at the margin and about half of it is ETF creation-redemption related. Most of what's invested in the market doesn't move an inch. It also explains the depth-plumbing ratings of financial television. People are behaving differently with their assets, both individuals and the professionals who invest for them, and the TV networks haven't figured out the right programming to cater to them. The community of really active traders that everyone in the financial media is trying to reach has been estimated at just 3 million. I'd take the under.

By the way, you can catch Josh on CNBC's Fast Money!

In my sample size of "me," I would take the under as well. I've evolved from an extremely active trader to a very inactive one. And the few trades I do are not intended as flips. I focus way, way, way more on asset allocation. Between my personal strategy and the invention of Twitter and StockTwits, I consume very little financial television.

His grand theory here also has very real implications for our world of volatility observation and trading. Quite simply, it implies lower realized volatility over time. We're still going to have cycles and CBOE Volatility Index (VIX) "Regimes," but it suggests lower baseline values for volatility regardless of the near-term backdrop.

As I mention very often, VIX futures perpetually overprice the probability of a volatility pop out in time. Since the recovery that began in 2009, we've gotten about 3-4 "overbought" VIX pops per year. I define them as pops that take the VIX 20% above its 10-day simple moving average, but using something like Bollinger Bands works just as well. No one's saying that dynamic is going to change … or, at least they shouldn't. We're still going to have "accidents" and shake outs. What it does suggest, though, is that these pops may trend towards relatively brief and shallow.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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