Tranquil markets are enjoying too much of a good thing; After years of monetary experiments, central banks will do ‘whatever it takes’

May 29, 2014 5:16 pm

Tranquil markets are enjoying too much of a good thing

By Gillian Tett

After years of monetary experiments, central banks will do ‘whatever it takes’

Something peculiar is happening in western capital markets. This month almost every measure of volatility has tumbled to unusually low levels. If you look at the degree of actual (or “realised”) price swings – and projected (or “implied”) future movements – investors are behaving as if the world is utterly boring.

This is bizarre. Financial history suggests that at this point in an economic cycle, volatility normally jumps; when interest rate and growth expectations rise, asset prices typically swing (not least because traders start betting on the next cyclical downturn). And aside from economics, there are plenty of geopolitical issues right now that should make investors jumpy. European elections have just propelled populist leaders into power, and events in Ukraine and the Middle East are tense.

But investors are acting as if they were living in a calm and predictable universe. Take a look, for example, at Wall Street’s so-called “fear index”, the Vix, which measures the implied volatility of S&P 500 equities. During the financial crisis this surged above 80, and later sank to half that; it is now just above 11, a low level not sustained since 2007.

Similarly, the “implied equity vol-of-vol” index (a derivative of volatility measures) is at its lowest level since 2006, and implied volatility in the euro-dollar currency markets is at its lowest since 2007. Bond price swings are very low too, and realised and implied price volatility for oil prices is also at a decade low.

“There is no demand for protection [against turbulence],” observes Mandy Xu, an equity derivatives strategist at Credit Suisse. “[Investors in] the options markets are not pricing in any big macro risks. This is very unusual.”

Why? If you want to be optimistic, one possible explanation is that the economic outlook has turned benign. For while western economic growth rates have been disappointingly slow since 2008, the good news is that recovery is now afoot, at a surprisingly steady pace. The disaster scenarios that used to spook investors – such as an imminent break-up of the eurozone or technical bond default in Washington – have not materialised; or not yet. More important still, after several years of wild monetary experiments, investors are more willing to accept that western central bankers will do “whatever it takes” to support the markets; they thus expect rates to remain stable and low for a long time – even if some central banks, such as the Federal Reserve, reduce their level of stimulus.

But there is a second, less benign possible reason for low volatility: markets have been so distorted by heavy government interference since 2008 that investors are frozen. One issue that may account for the pattern, for example, is that tougher regulations have prompted banks to stop trading some assets. Another is that ultra-low interest rates have made investors reluctant to deploy their cash in public, liquid markets.

And there could be a more subtle issue at work too: investors are so unsure what to make of this level of government interference that they are unwilling to take any big bets. Far from being a sign of sunny confidence in the future, ultra-low volatility may show that investors have lost faith that markets work.

In reality, nobody knows which of these explanations holds true; I suspect that government meddling and low interest rates are the key factors here, but academic research on this issue is thin. However, one thing that is clear is that the longer this pattern remains in place, the more wary investors and policy makers should be.

For while ultra-low volatility might sound like good news in some respects (say, if you are a company trying to plan for the future), there is a stumbling block: as the economist Hyman Minksy observed, when conditions are calm, investors become complacent, assume too much leverage and create asset-price bubbles that eventually burst. Market tranquillity tends to sow the seeds of its own demise and the longer the period of calm, the worse the eventual whiplash.

That pattern played out back in 2007. There are good reasons to suspect it will recur, if this pattern continues, particularly given the scale of bubbles now emerging in some asset classes. Unless you believe that western central banks will be able to bend the markets to their will indefinitely. And that would be a dangerous bet indeed.


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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