CFD MARKET STRATEGIST, GFT
VOLATILITY on the S&P 500 (as measured by the CBOE Volatility Index) has fallen by over 30 per cent since the end of August, even as equities and other financial instruments have ground higher. That was when Ben Bernanke signalled the likelihood of additional stimulus at Jackson Hole. By purchasing US Treasuries, the Fed is holding down fixed income yields, forcing investors to sell government debt and take on more risk to get decent returns. This became even more important when the Federal Open Markets Committee (FOMC) made it clear that they want to see higher inflation, reducing the appeal of bonds.
Now that renewed quantitative easing is finally under way, global equity markets (other than the Nikkei) are beginning to struggle. Bond yields have also risen. Investors are already concerned about what happens when easing ends. The Eurozone is back in the spotlight with growing fears that Portugal, Spain and even Italy may soon too require help. Last week, China also raised its reserve ratio in an attempt to counter inflation. Yet the volatility index (VIX) has barely moved.
The VIX measures the 30-day forward volatility of the S&P 500 using call and put options. A low number indicates that traders and investors are relaxed about future equity movements and so happy to hold long positions. High numbers indicate that investors are nervous and willing to pay more for insurance. Currently, the index is at around 21, which is pretty close to the long-term average and a lot lower than 33 where it stood before Bernanke’s speech. After the collapse of Lehman Brothers, it shot up above 80.
Despite last week’s price movements, investors remain remarkably sanguine. They may be right to be. But for less optimistic traders, now may be a good time to pick up some cheap insurance.