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Low volatility threat to shares

Stock market volatility has fallen. Investors should worry about this
Low volatility threat to shares

Stock markets have returned to normal. The Vix index – a measure of the implied volatility of S&P 500 options – has fallen to its lowest level since December 2019, ending 12 months of heightened volatility.

One obvious interpretation of this is that it signals that the risk of a significant fall in equities has declined. A Vix of 16.8 percentage points (its level as I write) implies that the market is pricing in around a 13 per cent chance of US equities falling by 5 per cent or more in the next month. That compares to a chance of more than twice that last summer, when the Vix was over 30 percentage points.

This does not mean the market has become complacent. Volatility is emergent: it is not a measure of the market’s mood, but rather the by-product of traders behaving for other reasons. If traders were complacent, they’d all be buying and so volatility would be high because prices would be rising a lot: this is what we saw in the tech bubble of 1999. By contrast, we get low volatility when traders disagree with as many being optimistic as pessimistic. When this is the case, buyers quickly find sellers and vice versa so prices don’t move much. Low volatility is therefore a sign of disagreement, not complacency.

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