Animal Spirits & The VIX13/03/2018
Many that bore witness to the events of the 5th of February saw a clear sign that volatility is back. As the S&P500 fell 4%, the CBOE Volatility Index, or VIX, experienced its biggest ever one day spike.
Since then equity markets have rebounded and volatility has retreated to levels slightly above the doldrums of last year. The question is whether this is the start of a new pattern, or whether the recent spike is just a blip.
One thing for sure is that short vol investment strategies were hit pretty hard that day and that money in this kind of investment remains in the market - be they direct plays on low vol or trend-following type investments, and opaque risks remain.
There are, according to Vineer Bhansali, CIO at LongTail Alpha, around $1.5 trillion in strategies linked to short volatility. How, when or if these remaining strategies unwind is where the interest lays.
How, when or if these remaining strategies unwind is where the interest lays.
Manesh Deshpande, global head of equity strategy at Barclays, described a scenario on CNBC’s Trading Nation called the ‘Market Up; Volatility Up’ dynamic. Where, similar to the late 1990’s, investors knew valuations were high, but didn’t want to miss out on the rally.
“It’s a similar situation right now, where if the animal spirits come back, then you could start to see a melt-up kind of rally…Where the market is going up and volatility is going up at the same time”
‘Animal Spirits’ is the term John Maynard Keynes used in his 1936 book, The General Theory of Employment, Interest and Money.
The original passage by Keynes read:
“Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities”
…and in commodities;
“Recent market movements resulted in sympathetic movements in commodities, more broadly though we see fundamental reasons for an increase in volatility in our space. With tariffs and concerns around trade wrestling with signs of strong global growth and a myriad of other concerns it seems inevitable that volatility will be in the spotlight.
The presence of programmatic sellers of this risk premium across markets means we think there is continued value for those willing to hold implied volatility in commodity markets” – Darius Tabatabai, Portfolio Manager at Arion Investment Management
In a rising rate environment with inflationary threats, wobbling credit markets and equities at all-time highs, it’s time to keep an eye on the silent assassin, the fear gauge, the VIX - even if markets continue to rise.
Author; James Purdie, Head of Investor Relations
Disclaimer: Although this document has been issued by Arion Investment Management, it is important to note that the views of the author(s) may or may not represent that of the company. The document has been derived from sources believed to be current and accurate as at the date of release. The comments made are general in nature and do not take into account anyone’s personal needs, financial situation or requirements and past performance is not an indicator of future returns. Before acting upon anything associated with this document we would recommend seeking advice from your financial advisor.
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About the company; Arion Investment Management Limited is a commodity focused investment management company, based in London. The company is authorised and regulated by the Financial Conduct Authority (registered no. 742037). Registered with the U.S. Commodity Futures Trading Commission (CFTC) as a Commodity Pool Operator and member of the National Futures Association (NFA).