Return of volatility sparks renewed fears over algorithmic trading

Markets were quiet – too quiet – as global stock markets enjoyed a steady rise over the past year. Now volatility has come back with a bang.

The Vix volatility index, the Wall Street "fear gauge" which tracks the fluctuations of the S&P 500 index, rose to a high of $37.32 last night, its highest since the flash crash of August 2015 – beating the Brexit vote, the election of Donald Trump, and the fears over a Chinese hard landing in early 2016.

Investor concerns about the high valuations of assets around the world are justifiable, said Nick Brooks, head of economic and investment research at Intermediate Capital Group, although he noted the last week’s fall is likely to be a “correction” rather than the start of a sustained bear market.

However, he cautioned that “2018 is likely to be a more difficult year” for investors. “We’re likely to see higher volatility and top-line returns are likely to be lower,” Brooks said.

The return of volatility offers "hard-boiled traders" the opportunity for returns, said Christian Gattiker, chief strategist and head of research at private bank Julius Baer, although less nimble investors should hold back, he added.

Wall Street feeding off itself

Yet if traders welcome the chance to make some money, the pace of the moves offers a more troubling signal, according to Simon French, chief economist at stockbroker Panmure Gordon. The plunge in stock markets on Wall Street last night started to "feed off itself quite violently", with the lesser known VVix measure – the volatility of the volatility index – reaching almost unprecedented levels.

The VVix spiked above $200 last night, with only the aftermath of the same 2015 flash crash – which was blamed on algorithmic trading by most market participants – beating it.

"It isn't healthy for asset prices to go in one direction," said French, but "it isn't healthy when price discovery is quite so violent."

Vicious volatility cycles

A crowded short trade on volatility may have "exacerbated the sell-off", according to Kyle Voight and Matthew Moon, anaysts at research house Keefe, Bruyette and Woods.

"A Vix spike past a certain level could have caused outflows and/or covering on short vol trades, which then in turn causes more market selling and higher implied volatility – a 'vicious cycle' to an extent," they said, although cautioning that information is still limited.

Daryl Liew, head of portfolio management at Reyl Singapore, said the current moves are "a healthy consolidation" after sustained rallies.

"We expect the markets to go through a stabilisation phase in the coming days and buying opportunities may emerge in selected markets," he added.

Let's block ads! (Why?)