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Dismiss December's market volatility spike as a one-off at your own peril

Publication Date: 25 Feb 2019 - By Gaurav Sharma (Associate Editor ReachX) By Gaurav Sharma (Associate Editor ReachX)
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Macro Investment Strategies Multi Asset Global

The depth and intensity of December 2018's market correction and volatility spike which came as a shock to investors was no one off, according to three city analysts. 

In a cross asset note to clients, Société Générale analysts Alain Bokobza, Arthur Van Slooten and Jitesh Kumar, wrote that mere two months later, however, what looked like a very bad omen in December is seemingly being viewed as a minor statistical disturbance that is best quickly forgotten.

(Source: Société Générale CIB)

“This view seems to be driven by the remarkable speed and strength of the subsequent recovery and drop in volatility. After all, risk assets are performing well again, and for the time being, we would advise keeping some tactical positive bias for equities while reinforcing portfolio protection in view of a potential increase in volatility. For us, however, it would be unwise to dismiss December's volatility spike as a one-off.”

The analysts looked look back to “the darkest days” of December trading, when stock markets plummeted and volatility accelerated sharply (VIX peaked at 36% on 24 December). Several explanations for this sudden and violent market behaviour have been suggested. 

“It seems likely that fears of a hard Brexit, the US government shutdown and the threat of additional trade tariffs on China played a role. But these factors appear largely insufficient to explain the spike in market volatility,” they added. 

“Similarly, it seems obvious that the subsequent market relief (S&P 500 +18% since 24 December, VIX down to 15.7% currently) cannot simply be a matter of disappearing Brexit fears (if only that were the case), a much more cordial relationship between the US and China or an end to the US government shutdown.”

The SocGen commentators said alternative explanations for this short-lived volatility increase have pointed to more technical factors, such as the sudden squeeze in order books that sent bid-offer spreads skyrocketing in a way strongly reminiscent of a similar event in February 2018.

“Our volatility strategists make the case that two such volatility flares in less than 12 months is no coincidence. The fundamental factor behind the expected shift to higher-volatility regimes is slowing economic growth. These volatility spikes almost confirm that we are now in a very late stage of the economic cycle. Some protection would seem justified,” they concluded. 

 

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