The volatility of the US stock market as expressed by the Vix index, published since 1990, is at its historical low. These days it stands at around 10; its apex of 45 was reached during the 2008 financial crisis. Low volatility is characterised by a long period of growth without market corrections.
Stock market behaviour is distorted: markets tend to rise slowly and gradually, then drop quickly and violently. It is almost impossible to guess the right time to get out. Counterintuitively, Vix’s low value is a sign of danger.
Three structural changes are the backdrop to this false tranquility: the ultra-expansive monetary policy on the part of central banks, the progressive reduction of the number of listed companies and the spread of low-cost passive investment strategies.
Since 2008, central banks in the US, Europe, the UK and Japan have flooded the financial markets with liquidity in a massive, coordinated effort through Quantitative Easing (QE) programs. The US central bank ended its program in October 2014. Europe, the UK and Japan should slow theirs down in the coming months. Coordinated QEs have never been undertaken in the past. Their curtailment may cause market instability.
In 1996 there were 7,322 listed companies in New York, today there are 3,671. At the same time, the market has risen by 500% and the average size of listed companies has doubled. Companies such as Apple, Amazon, Google, Facebook, Tesla, and others, which grew to over hundreds of billions of dollars, continue to grow in value on the expectation that expansion will continue without interruption. If their growth were to slow down, the market could have serious difficulties.
Exchange Traded Funds (ETFs) are low-priced funds affordable to anyone. ETFs replicate indexes without making a selection among quoted companies. When markets are positive, they help streamline investors’ liquidity easily and efficiently. As a result, any on-going market trend tends to strengthen. Similarly, ETFs could favor corrections if expectations should turn negative.
We do not know when volatility will come back. The next three months are traditionally the most difficult for the stock markets. The uncertainty in American politics and the instability of the North Korean dictator are other elements suggesting caution. It is advisable not to chase the markets up for fear of losing easy gains. If a correction does come, there will be precious little time to react.
L'articolo False tranquility of the market sembra essere il primo su Luigi Crosti.
