Displaying items by tag: volatility hedge

One of the most puzzling aspects of markets in 2023 for investors has been the relative weakness in volatility. This is despite a plethora of risks for the economy and markets including rising recession risk, elevated levels of inflation, a hawkish Fed, deep stresses in the banking system, and a looming debt ceiling standoff that seems certain to go till the deadline.

Yet, stocks are at their highest levels in more than a year, while volatility is at its lowest level in a couple of years. In an article for the Wall Street Journal, Caitlin McCabe discusses the potential impact of quant funds on volatility, and why it could potentially account for the discrepancy. 

Basically, quant funds have been piling into stocks even though most investors remain on the sidelines. Currently, these funds have a net exposure level to stocks that is the highest since December 2021, before the bear market started. In contrast, investors have a relatively low allocation to stocks and have reduced it this year. 

Some see risks in the concentrated positions of these quant funds which increase the odds of a market dislocation in the event of bad or unexpected news. Another factor in reduced volatility has been steady inflows from corporate buybacks. Overall, it’s been an exceptionally calm stretch with less than a 1% move for the S&P 500 in 36 out of the last 46 sessions. 

Finsum: One mystery for markets in 2023 has been the steady drop in volatility despite growing risks. One potential reason may be quant funds which are aggressive buyers of stocks. 

A perplexing situation is the sanguine state of volatility despite a torrent of risks and negative headlines such as deep stress in the banking system due to an inverted yield curve, rising recession risk, inflation, a hawkish Fed, geopolitical concerns, and a looming debt ceiling deadline. 

In Barron’s, Lauren Foster covered some recent comments from Vanguard on the debt ceiling and its impact on volatility. According to the asset manager, more volatility is likely but there’s little to worry about in terms of a default on the debt as it believes an agreement will be reached. However, it sees volatility rising into the deadline.

It also believes that the deadline could be shifted later or that a temporary agreement could be reached. Even if a technical default happens, it’s unlikely that the US would not meet its obligations but it could affect the timing of a payment. But, the asset manager doesn’t think that investors should worry about this scenario. Instead, they should focus on good risk management practices and sticking to their long-term investment plan. 

Finsum: Volatility has remained subdued despite the market facing considerable risks. Vanguard shares its perspective on the matter and how a debt ceiling breach would play out.

There are considerable headwinds facing the stock market and economy such as a hawkish Fed, uncomfortably high inflation, debt ceiling deadline, an upcoming election year, increasing risk of a recession, a potential regional banking crisis, and geopolitical tensions. 

Yet, the volatility index has trended lower for much of the year and is now at its lowest levels in over a year. Ron Isbitts covered this matter and why it could be an opportunity for ETF investors in an article for ETF.com.

If investors believe that volatility is mispriced, then there are some different volatility ETFs to consider. The ProShares VIX Short-Term Futures ETF offers exposure to volatility over the next 1-2 months. The ProShares VIX Mid-Term Futures ETF holds volatility contracts with a duration of 3 to 6 months. 

There are also ETFs for those with a variant view. The ProShares Short VIX Short-Term Futures ETF moves inversely to volatility, allowing holders to profit from falling volatility. For those who want to generate income from volatility, the Simplify Volatility Premium ETF also tracks volatility but also produces a dividend for holders. 

Note that these ETFs tend to have slippage, high costs, and underperform the S&P 500 over the long-term. Thus, they are best used tactically and with discretion.

Finsum: Volatility is declining despite several potent risks for the market. There are several options for investors to consider.

In an article for MarketWatch, Jamie Chisholm discussed some reasons for why stock market volatility has remained depressed despite the ongoing crisis in regional banks which some fear could lead to a credit crunch. In contrast, the stock market seems more responsive to economic data and the Federal Reserve. 

Economic data continues to signal an economy that is growing albeit decelerating but also not in a recession which would hurt corporate earnings. Q1 earnings also have come in stronger than expected. 

The Federal Reserve is in the final innings of its rate hike cycle. Futures markets are already looking ahead at rate cuts by the end of the year or Q1 of next year. And, inflation data continues to moderate and move in the right direction which is also supportive of asset prices. 

It’s also surprising that the market seems unconcerned about the debt ceiling deadline and a potential default, although there has been chatter about positive progress from negotiations between Republicans and Democrats. Surprisingly, the regional bank crisis is having little spillover impacts on the market or economy. In fact, the S&P 500 is 3% higher than from when the crisis began, while the Vix is nearly 10% lower. 

Finsum: One mystery for market participants is that volatility remains depressed despite ongoing struggles for regional banks and a looming debt ceiling deadline.

In an article for MarketWatch, Mike Murphy covered a recent report that state and federal regulators are examining unusual trading patterns behind the recent volatility in bank stocks. Notably, the entire banking sector and specifically regional banks, have been subject to heightened volatility and heavy short-selling in recent months following the failures of banks like Signature Bank, First Republic, and Silicon Valley Bank.

In recent weeks, there have been big declines and large amounts of put buying in the stocks of regional banks like PacWest, Western Alliance, and Zions. The core challenge for these banks is that they made long-term loans at much lower rates, yet they have to increase short-term deposit rates or risk depositors leaving for higher rates elsewhere. And the risk of this deposit flight increases if concerns about a bank’s financial health increases.

Both the White House and the SEC noted the short-selling pressure on banks possibly contributing to the volatility. In a statement, SEC Chair Gary Gensler said, “In times of increased volatility and uncertainty, the SEC is particularly focused on identifying and prosecuting any form of misconduct that might threaten investors, capital formation or the markets more broadly.”

Finsum: With increasing volatility in the banking sector, regulators and public officials are examining short-selling and put buying as factors that may be adding to volatility.