Calmer markets – we shouldn’t be complacent but they might help the real economy

5th August 2014 by James Mahon

There is media concern at present about volatility (the lack of it), why this might be and whether it is a sign of complacency and problems in store. Principally, this seems to be focused on the level of volatility being down to pre-crisis levels again. This chart of the VIX, which is an American measure of stock market volatility for which we have the best long-term information, illustrates the point:

CBOE S&P 500 Volatility Index (‘VIX’) 1990 – 2014
Source: Bloomberg

The various crises of the last twenty-five years show up well on the chart: the recession of the early 1990s, the Asian and LTCM crises of 1997/8, millennium bugs and the bubble around the turn of the century, 2008 and the eurozone problems of 2011. Clearly, the VIX is firmly at the bottom of its long-term range now, and, on this basis, looks more likely to rise again than to fall further. Whether this is a portent of doom is another matter.
Clearly it is possible to identify a number of potential threats to the present calm: notably from the Middle East and central bank management of the turn in interest rates. Equally, there is an unhealthy ‘thirst for yield’ and the return of leveraged Collateralised Loan Obligations (CLOs), and demand for ‘junk bonds’ in response to this is not a good sign. We do expect volatility to pick up in the second half.

So, yes, calmer markets can lead to complacency and the sort of problems arising from excessive debt that we saw in the financial crisis. But they can also provide a better backdrop for a recovery in the ‘real’ economy which was, after all, a core aim of US and UK central bank’s ‘forward guidance’.

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