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Forget VIX and chill: is low volatility a sign of complacency?

Forget VIX and chill: is low volatility a sign of complacency?

Are markets getting complacent? Traditional measures of fear in the market, including the S&P’s 30-day average volatility and the CBOE’s VIX index – which measures implied future volatility – suggest that global investors are relaxed despite a risk-laden geopolitical backdrop.

A small, but influential group of investors think that this could be a problem.

On Monday, Singapore’s state-owned investment vehicle GIC warned that there was a worrying degree of complacency in markets, and that investors were probably not correctly pricing in the risk of short- and long-term threats to the global economy. Lim Chow Kiat, GIC’s CEO, said that the fund was ‘prepared for a period of protracted uncertainty and low returns.’

A day later, the city-state’s other state-owned investment company, Temasek, warned that public and private market valuations are ‘stretched’, which ‘poses risks to the returns that equity investors will be able to achieve in the future,’ Michael Buchanan, Temasek's head of strategy, told a media briefing on Tuesday.

‘First and foremost, you cannot confuse low market volatility with low risk. There are a lot of uncertainties in markets. We are going to see the start of tighter monetary policy. Geopolitical risk is always there. We are seeing a lot of complacency setting in,’ James Cheo, investment strategist at Bank of Singapore, told Citywire Asia.

‘Economic growth is moderating. The monetary support that we saw over the last seven, eight years is going to be tighter, he said. ‘Markets are going to have to price some of these things in. You would expect some volatility, you would expect valuations not to be at current levels.

Political noise

The geopolitical backdrop is a complex one, with significant individual events – elections, conflicts and trade disputes – playing beneath the shadow of real threats to the global consensus on free trade that has underpinned much of global growth in the past few decades.

US president Donald Trump has been making policy on the hoof since January, driving a frenetic news cycle in which it is difficult to discern signal from noise. The administration has weathered a string of overlapping scandals, some which retain the potential to fatally undermine the government, and recent stories do not suggest that the situation is stabilising.

An email chain released earlier this week seemed to prove that President Trump’s son, Donald Junior, was aware of Russian attempts to influence the 2016 US presidential elections, and met with a lawyer connected to the Kremlin before the vote.

June elections in the UK delivered a result that few in the markets had anticipated, leaving prime minister Theresa May without a working parliamentary majority or a clear mandate to negotiate a “hard Brexit” -- the country’s exit from both the European Union and the European Single Market. Fears of a bad deal are already dragging down growth in the UK, and at the margin there are huge risks to both parties in the negotiation.

Elsewhere in the G7, Japan’s prime minister has a fight on his hands to stay in power, after his Liberal Democratic Party was battered in the symbolically important Tokyo metropolitan elections, and his poll ratings slipped to their lowest since his election in 2012.

A standoff in the Gulf between Qatar and its neighbours continues unresolved, pitting a Saudi Arabia-led bloc against a small, but influential state that is aligned with both Iran and Turkey.

North Korea has conducted 10 missile tests this year, including that of an intercontinental ballistic missile in July, ratcheting up the tension in the Korean peninsula and dragging in regional and global powers.

‘Currently financial markets are not pricing in this geopolitical risk. They should take into account some of that,’ Cheo said, although he added that geopolitics has rarely been the driver of major market moves.

At M&G Investments, investment director Jeik Sohn said that ‘there’s a lot of conversations happening internally,’ but that he was not convinced that low volatility, as measured by the VIX, is necessarily a sign of complacency.

‘[The VIX] has been relatively steady because the macro data has been pretty positive all year. There have been no real surprises for a fund management perspective,’ he said.

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