Volatility retreated across asset classes in the first half of the year as developed nations emerged from the worst of the Covid-19 pandemic. Its potential return may not mean the end of good times for risk assets.
The Cboe Volatility Index, or VIX, has fallen more than six points this year, close to a 16-month low, while the Cboe High Yield Corporate Bond ETF Volatility Index closed at its lowest level since January 2020 on Tuesday, sent lower by central bank largesse and progress against the coronavirus.
At the same time, indicators of investor anxiety, like skew — a gauge of how expensive bearish bets are relative to bullish ones — are near record highs. That’s prompting warnings from strategists that volatility is poised to return, with threats from Covid variants to tighter monetary policies looming.
The dueling narratives from options-derived indicators is a microcosm of the first half, where investors have pushed stocks toward records even as concerns mount that virus variants could force new lockdowns and central banks will tighten policies. The same strategists warning on volatility are, unusually, still forecasting further gains for risky assets, including equities. They argue reopening economies around the world should power gains throughout the year, even if turbulence returns to markets.
“We are not complacent about the potential for trouble and investors shouldn’t be, either,” BCA Research strategists including Doug Peta and Sara Porrello wrote in a note on Monday that reiterated their recommendation to go overweight on equities.
On the one hand, investors are tracking where Covid-19 infections will surge next, which governments might order a lockdown, and where vaccination rollouts are fastest. On the other, a risk-on narrative has taken hold after countries unleashed floods of fiscal and monetary stimulus to combat the economic damage. Any optimism is complicated by the question of when the largesse gets dialed back.
“We advise investors to brace for bouts of volatility ahead,” Mark Haefele, chief investment officer for global wealth management at UBS AG, wrote in a note Monday. “At the same time, we don’t see record highs as a barrier to further gains.”
Fundstrat Global Advisors LLC projects near-term bumps but longer-term gains. The firm raised its 2021 S&P 500 price target to 4,600 from 4,300 in a recent report.
“Strong markets stay strong,” analysts at the group, which was co-founded by Tom Lee, wrote. In years when the S&P 500 rises by more than 13% in the first half, the median return in the second half is 9%, they said, using data going back to 1928.
The gauge is up more than 14% in the year so far — meaning next month could be “brutal” because “July returns are worse when the first half is strong,” they said.
And the proliferation of Covid-19 variants raises the chance of a “Black Swan” event, according to Viktor Shvets, head of Asian strategy at Macquarie Capital, referring to something unique and unexpected that has a major impact.
“Essentially one should be ready for high volatility of outcomes, as churning within and between asset classes and styles increases, even if headline indices remain flattish,” Shvets wrote in a note Tuesday.
Investors should enjoy the ride while it lasts, but if things go wrong, they’ll go wrong fast.
“We expect that the just-right Goldilocks backdrop of strong growth and easy monetary policy will remain in place through 2022,” the BCA Research strategistssaid. “But investors should be prepared to implement an alternative course of action if it doesn’t.”
–With assistance from Sunil Jagtiani.