Lower Volatility

Hedge funds and other short-term tactical investors have long been regular users of ETFs to adjust positions and seek to profit as indexes twist and turn. However, the current market environment is characterized by low levels of realized volatility, as well as expected volatility as reflected in the VIX.  Realized S&P 500 volatility has been very low—6.7 percent year-to-date in 2017—and the VIX has been settling at the low end of its range, below 10 percent on most days. So far this year, only 3.6 percent of trading days have had moves of 1 percent or more. This low level of broad index volatility is both a cause and effect of less tactical and macro-related trading, and its persistence is a strong sign of a regime change to more of a stock pickers market. These conditions have been in place before—more than a decade ago in 2004 through 2006—but since the financial crisis, news of interest rates and global economic developments and macro strategies have dominated. 

Lower Correlations

Lower correlation across stock returns is another sign of a shift to a stock-pickers, bottom-up market, which typically is dominated by stock-based investors with longer horizons. Cross-stock correlation measures the extent to which stocks in an index move together and tends to be highest when more tactical, top-down (macro) investors are dominating flows and price discovery. In a stock-pickers market, price moves are more often based on company fundamentals, reflecting the bottom-up stock focus on the part of investors dominating equity flows. A monthly report provided by S&P Dow Jones Indices shows that as of the end of October, the S&P 500 cross-correlation measure was 0.06 compared to a median level of around 0.35, according to S&P Dow Jones Indexes, Dispersion, Volatility, and Correlation Dashboard, October 2017. Readings of this measure for most months in 2017 have hovered in the range of 0.05 to 0.25, significantly below normal.


The Implications Of This Shift To Longer-Term Investment Horizons

Mostly, this shift is good news for stock issuers who can tilt decision-making to longer-term growth and profit opportunities. They can expect less volatility from news related to short-term earnings and economic and industry factors outside of their control. Strategies like option and volatility selling, which benefit from stable and falling volatility, have moved into favor for their features of income generation as well as their strong returns in this environment. Of course, businesses like exchanges and brokerage firms, whose revenue is driven by high levels of trading activity, have less to be happy about.