Financial market volatility is back.
After sliding 2.12% on Friday, the US S&P 500 Index tumbled by a further 4.1% today, the largest percentage decline since November 2011.
From the record peak of 2,872.87 points struck in late January, the index has now lost 7.8%.
It’s getting ugly for investors. The tranquility seen over the past few years has now suddenly come to an end.
And it looks like the recent bout of volatility may persist for a while, at least based on the view of options traders.
The chart below shows the daily movements in the CBOE Volatility Index, or VIX for short.
Using options pricing, it measures the degree of volatility in US stocks looking one month ahead.
On Monday, the index spiked to 37.32, the highest level since August 2015, suggesting that volatility is likely to remain extremely elevated in the month ahead.
To put its current level into perspective, the last time the VIX was this high was when the People’s Bank of China made a change to its daily rate-setting mechanism for the Chinese yuan, resulting in a devaluation of the currency.
For months, that reverberated across markets, climaxing in early 2016 when there were real concerns emerging about the strength of the Chinese economy.
While those concerns never eventuated, at least not on that occasion, it underlines why investors should expect volatility in stocks to persist for some time yet.
Chris Weston, Chief Market Strategist at IG Markets, put some colour on the spike in the VIX seen on Monday in a note this morning.
“It’s all systematic fund sellers in this market,” he says. “Anyone running short volatility positions, or who use volatility as an input, has run for the hills.”
Weston says what started as concern that building inflationary pressures in the US would see the Federal Reserve hike interest rates faster than markets were expecting has now morphed into a move being driven by a degree of investor panic.
“One of the key reasons why we are seeing this crazy price action has been higher ‘real’ and nominal bond yields and here, today, we can see traders piling into the long-end with 10-year US note yields falling 7 basis points to 2.73%,” he says.
“So what started as a belief that the Fed are thoroughly behind the curve has turned into a story of investors progressively buying into the inflation story and this has morphed into a view that tighter policy is due to come.
“This is now a pure risk aversion move.
“All stocks bar two closed lower in the S&P 500 and volumes were 72% above the 30-day average. There were simply no buyers, a lot of forced sellers and a ton of high frequency [trading] activity.”
It’s going to be an interesting few sessions ahead.
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