Forget fallout from the midterms, a murdered journalist, Brexit or the trade war. The biggest reason to brace for enduring stock volatility may be the simplest: It’s just time.
Bank of America Merrill Lynch’s equity and quant team say market signals from the ever-flattening yield curve are clear as day: stock markets are due to begin a new era of elevated price swings.
“A flattening yield curve signaled a withdrawal of liquidity and over the last three cycles has preceded rising volatility by a few years,” the team, including Savita Subramanian, wrote in research this week. The curve has been flattening “over the past couple of years,” they noted.
It’s a version of the quantitative tightening argument for why volatility is climbing: The unprecedented tranquility in stocks seen through the start of the year was a byproduct of extraordinary global stimulus, and it’s reversing as the tide of liquidity recedes.
Bank of America’s call -- echoing others -- comes as investors scramble to judge whether the current turmoil in equity markets represents a blip or fundamental shift in regime. Hedge funds that reaped fortunes betting against share swings are nursing losses once more, with echoes of the February tumult.
Doubling Down
In some respects, BAML is doubling down on an earlier prediction that liquidity would see an outright contraction by the end of the year. So far, the evidence appears to be moving in the strategists’ favor. The Goldman Sachs U.S. Financial Conditions Index is marching ever higher. The gauge tracks changes in interest rates, credit spreads, equity prices and the greenback and rises as financial conditions tighten.
Against that backdrop, the S&P 500 Index slumped 5.4 percent this month through Monday, while the Cboe Volatility Index -- a measure of 30-day implied volatility for the U.S. benchmark -- touched its highest since February. Known as the VIX, it has since retreated, but remains above its one-year average.
Goldman Sachs Group Inc. reckons economic growth is the key driver of volatility. The bank is predicting a moderation of U.S. expansion next year, and in a note on Monday said that’s likely to boost S&P 500 volatility by three to six points.
Still Short