Investors prepare for ‘regime change’ as market volatility returns

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Investors are bracing for more volatility this summer after the calm of global financial markets this year was shattered.

The surge in the Vix index — the market’s “fear gauge” that shows how far investors expect U.S. stocks to swing over the next month — to its highest level on Monday since the coronavirus pandemic began in early 2020 could signal a tougher period for global stocks and ease worries. capital market activity in the short term, analysts said.

“This is a regime change,” said Ajay Rajadhyaksha, global head of research at Barclays, who described the Vix peak on Monday as “quite scary.”

“I find it very hard to believe that you will go back to business as usual,” he added.

The US stock market entered the second-quarter earnings season in early July in its sleepiest state in years by some measures, with the S&P 500 posting steady gains to a record high and the Cboe index at a four-year low in historical volatility.

But investors were in for a shock. Sharp declines in recent days have pushed the S&P down about 7 percent from its peak, even after a partial rebound on Tuesday. The Vix jumped 65 percent on Monday, its biggest one-day gain in more than six years. At its intraday high, the index was up 180 percent, its biggest gain in at least 20 years. Options trading tied to the Vix hit a six-year high on Friday.

Three-month implied volatility on Monday rose above one-year volatility expectations for the first time since the banking crisis in March 2023. Max Kettner, chief multi-asset strategist at HSBC, said this was a sign of “genuine panic” affecting some investors.

“People are suddenly willing to pay a premium for short-term protection, they don’t care what might happen months from now, they want to be protected now,” he said. “That’s a completely different mood from just four or five trading sessions ago.”

Traders said higher volatility This means that hedge funds and other investors who closely monitor how much they can lose are having to cancel even profitable trades to cut their risk exposure. This can lead to excessive price volatility in many asset classes.

“Risk management teams will tap traders on the shoulder and say ‘you have to cancel this trade’ even if it is making money,” said a fixed income and currency trader at a major European bank.

“Or if you have a losing trade and another one that is making money, you will have to cancel both. That’s why you see weird moves,” the person added.

Among retail investors, visits to Vanguard’s investment platform were more than double the previous peak set during the pandemic meme stock frenzy. Retail investors were “active net sellers” in the market on Monday, pulling more than $1.4 billion out of individual stocks, according to JPMorgan research.

“Everyone switched sides of the boat saying everything was fine,” said Eric Veiel, chief investment officer at T Rowe Price, which manages $1.5 trillion in assets. “Then people started reassessing the fundamentals of the economy… in buoyant markets, and that led to a sharp reversal.”

The return of volatility could dampen activity in capital markets. August is traditionally a quiet month for initial public offerings, but bankers had hoped to see some bond deals and a spate of large equity sales and convertible bond offerings by publicly traded companies.

“This week is shaping up to be one of the busiest weeks of the second half of the year,” said Maureen O’Connor, global head of senior debt syndication at Wells Fargo. “There have only been seven deals to market so far. That tells you how many more are waiting to come to market.”

The market sell-off was triggered by a combination of weak economic data and disappointing corporate earnings. But as the sell-off accelerated on Monday, many traders said the downturn was exacerbated by investors being forced to unwind their positions. Traders who had borrowed in yen to buy higher-yielding assets, for example, were forced to sell those assets quickly as the Japanese currency rose rapidly.

While Friday’s sell-off “wasn’t really that much panic,” the Vix’s spike above 60 “wasn’t related to fundamentals at all,” said Mandy Xu, head of derivatives market intelligence at Cboe.

Meanwhile, Sonal Desai, chief investment officer of bonds at Franklin Templeton, said the move in the bond market showed “the market is pushing very, very hard” for the US Federal Reserve to cut interest rates.

“If the Fed gives in to what the market is demanding right now, it will create more volatility because it looks like the Fed is nervous,” she added.

There are signs that some investors are expecting volatility to fall again. The biggest increase in Vix options trading has been in put contracts — the right to sell at a fixed price — essentially bets that the Vix will fall again in mid-August or mid-September.

But many traders remain wary of a return to the previous calm, as markets react so violently to economic data.

“Locations [that were hit on Monday] “It’s all very crowded,” said Veiel at T Rowe Price. “Stocks will start to look more attractive because their prices have come down…[but]It would be arrogant to predict with certainty that this is the bottom.”