Although volatility has collapsed in the era of quantitative easing, in those periods when it has increased, it has generally risen unusually fast and created much pain for investors. Take the CBOE Volatility Index, or VIX. Even though it is more likely to stay below 20 these days, it is twice as likely to surge above 40 when it does rise. It doesn’t help that passive investment strategies make up half of all share trading, twice as much as 10 years ago, meaning there are fewer humans at the helm to make rational decisions when markets go haywire.
What’s more, market makers hold a tenth of the trading inventories they had in 2007, according to data from the Federal Reserve Bank of New York. As a result, they are unable to act as a sort of market shock absorber during periods of rapid price swings like they had in the past. That combined with capital flocking in and out of the same trades means markets are breaking down more often.
A good example comes from March, when exchange-traded funds owning investment-grade corporate bonds experienced price declines exceeding 10%, dropping 4% to 5% below their net asset values. Worried that the episode might cause credit markets to stop functioning, the Fed stepped into the markets to buy corporate debt for the first time.
2019 was one of the best years ever for the balanced 60/40 portfolio. That helps to highlight that it might still be premature to suggest the age of balancing bonds versus equities is dead. Obviously 2020 has been a very difficult year where risk takers have been rewarded and savers have been denuded of income. The challenge for long-term investors is the low interest rate environment distorts valuations so that momentum strategies tend to trump everything else.Click HERE to subscribe to Fuller Treacy Money Back to top