Volatility divergence

Grandriver / Getty Images
Grandriver / Getty Images

Back before the holidays I highlighted what I thought was an unsustainable trend: low equity market volatility . Since then, U.S. equity market volatility has continued to decline; last week, the VIX Index -a commonly used measure of equity volatility-dropped below 11, the lowest level since the summer of 2014, before the U.S. travel ban-related selloffs sent the index climbing earlier this week to near 13. Still, the VIX is very low by historical standards, and this is occurring against a backdrop of considerable political uncertainty. What is causing this and can it continue? Equity investors are enjoying an unusually tranquil start to the year, particularly in contrast to last January. Benign credit markets and a more robust economy deserve much of the credit. As I've written about in the past, equity markets rarely struggle when credit conditions are benign. This is why high yield spreads explain approximately 60% of the variation in the VIX. Back in late October high yield spreads were already low, at around 470 basis points (bps). Since then they've moved even lower, falling below 400 bps for the first time since the summer of 2014. As tighter spreads indicate more confidence, one would expect volatility to fall, albeit not quite to these levels. The second factor driving volatility is economic growth, or more accurately, expectations for growth. This time last year investors were worried about another recession. Today they are raising their estimates for growth. Since the election, 2017 U.S. consensus growth estimates have increased by 0.2%. Most leading indicators suggest that despite political uncertainty, both U.S. and global growth are firming. Historically, expectations for accelerating growth generally coincide with lower volatility.

What's the catch?

the VSTOXX Russ Koesterich
, CFA, is Portfolio Manager for BlackRock's Global Allocation
team and is a regular contributor to The Blog .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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