The View | The only thing markets have to fear in 2018 is fear itself
While the list of catalysts that could lead to a downturn is extensive, it is the fears of “short-vol” investors that pose the biggest threat to sentiment
If there was one word that described financial markets in 2017, it was tranquil.
The last 12 months have been the calmest period for US stock markets in more than half a century, with the daily change in the benchmark S&P 500 equities index dropping to its lowest level since 1963. According to Bloomberg, the average level of the VIX Index, Wall Street’s “fear gauge”, which measures anticipated volatility in the S&P 500, in 2017 was 11.1, or roughly 10 per cent lower than the next closest year. The VIX stood below 10 – a record low – for as much 20 per cent of the time in 2017.
For many investors, the unprecedented calm has lasted too long and is storing up trouble, desensitising market participants to the plethora of vulnerabilities in the global economy and, more worryingly, encouraging investors to place big bets on a continuation of the period of low volatility.
The so-called short-vol trade, or selling volatility, now amounts to about US$2 trillion (roughly the size of India’s economy), according to a report by Artemis Capital Management, a US hedge fund, increasing the scope for a disorderly sell-off if volatility erupts again.
At the end of 2017, there were signs that investors were becoming more nervous. Research from the New York Federal Reserve shows that investors are paying significantly more to protect themselves against a surge in volatility in one to two years’ time than was the case before the 2008 financial crisis.
This suggests that while investors believe the calm is likely to persist in the coming months, trading conditions could become a lot choppier towards the end of 2018. The question on every investor’s lips is – what is most likely to trigger a downturn in markets?