Schaeffer's Trading Floor Blog

The New Face of Volatility

Examining the recent volatility backdrop

by 5/16/2014 7:27 AM
Stocks quoted in this article:

If you want to guarantee that volatility will pick up, just write an article about how volatility will never pick up. I feel like I've literally caused every mini-pop in volatility over the last decade just by noting how nothing much is happening. Anyway, I'll turn that mantle over to the The Wall Street Journal's MoneyBeat column from yesterday morning, titled, "The Death of Volatility?":

"It is time to ask the question that dares not speak its name (at least on options desks): are we witnessing the death of volatility?" Nicholas Colas, chief market strategist at New York brokerage ConvergEx Group, asked in a research note this week. "Are we so accustomed to central bank intervention that any negative macro action has an equal and offsetting policy reaction?

The VIX has been low for the past few years, a far cry from what transpired in the second half of 2011 when it rose to the low 40s after the downgrade of the U.S. credit rating and during the European debt crisis. The fear gauge nearly hit 90 in October 2008 during the depths of the financial crisis.

"Current risk pricing in U.S. equities seems to point to something being 'different' this time around," Mr. Colas said.

"... We are not seeing any sort of major hedging activity," Steven Rosen, head of single-stock and ETF volatility trading at Societe Generale in New York, told MoneyBeat earlier this week. Lately, for clients, buying insurance "just seems like a waste of money. Every selloff we have, you only see money come in to buy the market higher."

Of course, yesterday saw an actual surge in volatility. But, the CBOE Volatility Index (VIX) rallied all the way to a 13 full, which essentially reinforces the exact points he's making here. On the surface, there's not an awful lot of fear. We had a very ugly day in the markets, and all evidence points to big players fading the dips.

Of course, Big-Cap does not an entire market make. That Russell 2000 Index (RUT) rally the other day now looks like a dead-cat bounce. The iShares Russell 2000 Index ETF (IWM) touched its 2014 lows, and the CBOE Russell 2000 Volatility Index (RVX) is back in the 20s. The RVX/VIX ratio hit all-time highs (all-time only going back to 2007, as we noted the other day).

I think I could personally argue the market both ways here … which I guess means I'm not a buyer of volatility. On the negative side for the market, I can't imagine momentum and small-caps can stay this ugly and volatile without eventually spilling over to bigger-caps.

On the positive side, the ostensible reasons for yesterday's sell-off don't feel like anything that will set us into a downward spiral. "Big Hedge Fund Guy Who Called Bull Move and Is Now Possibly Turning Bearish" is never a good dynamic to tail. As smart and successful as these guys are, they didn't get to their positions with perfectly timed macro-market calls that fit into a three-minute TV segment. There's about a billion moving parts to their equations that don't apply to any of us, most importantly the difficulty in moving around a gigantic portfolio. Many of these giant hedgies have been publicly cautious on the markets for a while now, and still piling in great returns in their funds. It's very informative to listen to their perspectives, but it's not going to do an enormous amount for your personal investment returns.

And reason number two for the sell-off was apparently Europe. We've seen that movie many times, as well. We tend to obsess over some small-ish economy for a few days or a week, and then forget they exist.

I think the real reason for the ugliness is that it's 2014. Big-caps did well earlier in the week, which of course means they must do poorly later in the week, lest the market actually move at all net-net. Churn, Baby, Churn.

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


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