Stephen Diggle, who co-founded a hedge fund that made $2.7 billion in the depths of the global financial crisis, said the resurgence of volatility is here to stay as bonds and stocks are both way overvalued.

Markets have been roiled by massive price swings over the past week, punishing investors who were betting on an extended period of calm. Stocks slumped and bond yields surged on concern a stronger U.S. economy will stoke inflation and push up interest rates faster than the market has priced in. The Cboe Volatility Index -- known as the VIX -- surged to a more than two-year high on Tuesday.

“In the short term I think volatility can remain elevated and the VIX as well,” said Diggle, chief executive officer of Singapore-based family office Vulpes Investment Management. “There have been so many persistent volatility sellers for such a long time that the market has been seriously out of balance for a while.”

Diggle said he’s gained from the surge in volatility after buying December put options on the S&P 500 two weeks ago at strike of 2,200 as “crash protection.”

“They doubled overnight, so I’m feeling rather pleased with myself,” he said Tuesday.
While record stimulus from the biggest central banks has damped price swings in recent years, the Federal Reserve’s progress in trimming its debt holdings has seen Treasury 10-year yields climb to a four-year high this month. A better-than-expected payroll report last week spooked investors and sent the Dow Jones Industrial Average to a record points loss on Monday amid concern inflation will accelerate.

‘Greatest Risk’

“The lack of fundamental value in either bonds or stocks is the greatest risk,” Diggle said. “All markets must eventually come back to attractive value and this is a very, very long way down for both stocks and bonds. The broad economy and corporate profitability are both strong, and that’s important, but value is what provides the best support and it’s nowhere to be seen.”

Both sovereign and corporate bonds are expensive, though sovereign bonds “set the floor," Diggle said. U.S. yields “have moved off that floor now," but Japan and Europe are still firmly on it, he said.

Diggle set up Vulpes in 2011 after liquidating the volatility funds at his previous company, Artradis Fund Management, when price swings declined. A graduate of Oxford University, he worked at Lehman Brothers Holdings Inc. before co-founding Artradis in 2001.

Vulpes, which has $400 million of assets, also owns Singapore-based Kit Trading Fund, which manages a multi-strategy hedge fund. Family offices are typically tailored to both investment and personal needs, including estate planning, philanthropy and maintaining homes.

Expensive Equities

But he doesn’t plan to restart a long volatility fund. Central bank pledges to clamp down on volatility has smothered price swings and there are also “still far too few” listed long-volatility vehicles, he said.

“Most are still over-the-counter products offered by banks that in the last crisis were the epicenter of the insolvency,” Diggle said. “So if you buy a long volatility product from a bank, you must always be worried whether they will be able to pay you if volatility spikes enormously.”

Vulpes has stayed clear of equity and bond markets for some time, and isn’t planning to buy on the recent dip, Diggle said.

“I’ve no idea how to trade a market like this, equities are as expensive as they have been only three times in the last 100 years: the 1920s and late 1990s and now,” he said.

“And bonds are more expensive than at any time in recorded history. Possibly they were this low during the Black Death in the 1340s -- data for the period is not great.”

A change in leadership at the Fed has also fueled uncertainty over the path of U.S. monetary policy. Jerome Powell was sworn in as chairman of the central bank on Monday. Equity prices were "high," his predecessor Janet Yellen said in an interview with CBS on the weekend.

“All eyes therefore will be on the Fed and its brand new chairman, who is in a tough spot, as clearly the long-awaited wage inflation means the Fed now looks behind the curve,” Diggle said. “I’ve no doubt the Fed has a plan, but what the pain point is, is anyone’s guess.”

This article was provided by Bloomberg News.