Volatility is generally low when things are good and stock markets aren’t prone to jump around too much. However, many financial experts argue that when the VIX, a measure of expected volatility, is as low as it is now, it implies there is a lot of complacency in the market, and the likelihood of problems ahead is heightened because investors are not prepared for it.
Russ Koesterich (pictured), BlackRock’s global chief investment strategist, said: “Low volatility can have a downside, in that the market may be vulnerable to a slide should there be any outside shocks – a possibility with key elections taking place in Europe and Ukraine.”
Earlier this month, Societe General released figures which paint an eerie picture: "It has now been 468 days since a market correction of 10 per cent or more, the fourth longest period on record.” Peter Lowman, chief investment officer at London-based discretionary manager Investment Quorum, thinks the warning signs are in place for a correction.
“I’m Mr Doom here. I’m very cautious. It’s probably my age,” he said. “The VIX is obviously at the moment not giving anybody any real concern, but the US is at a pretty high level and it keeps breaking through its previous highest level in history. It all looks pretty toxic really.”
This week, the S&P 500 smashed through 1,900 points, closing at 1,911 points – its highest on record – on Tuesday.
Year-to-date performance of S&P 500
Source: FE Analytics
While Lowman admits some investors, like himself, are showing signs of nervousness, he says markets are currently being kept afloat by central bank policy and intervention which could keep equities rising for some time, but not for ever.
He highlights that any concern about rising interest rates has been underpinned by central bank leaders like US Federal Reserve Chairman Janet Yellen, who continue to assure investors that rates won’t be rising anytime soon.
The investment officer adds that investors face a conundrum – if they pull out of the market now on fears of a correction, they are faced with the prospect of losing yields and growth because cash and bonds are still languishing at record-low yields.
“We’re all sitting her really quite nervous but we remain fully invested because we need to get returns for our clients,” he said. “We’re just at a crossroads at the moment where investors are a little bit nervous but its best to go for equities – you know, the best of a bad bunch.”
Lowman says if the market does correct this year, it will like be in July or August when liquidity is low and many people are on holiday – including government officials and central bank officers – so they won’t be releasing as much news to calm the markets. However, he says it is likely equities would bounce back by the back end of the year.
“We should all learn that situation where there’s going to be something coming through and bringing us back to reality,” he said.
Alice Gaskell, manager of the BlackRock Continental European Income fund, also recently warned a market correction was on the horizon for European equities, citing uncertainty surrounding the recent European elections.
Old Mutual’s Richard Buxton, who has long stood in the bull camp, thinks that the shift is simply a market and investor positioning issue rather than a cue for a correction.
“It rightly forces you to re-examine your views and convictions, but I remain of the view that this is more of an internal market and positioning issue than anything more sinister,” he said.
Hargreaves Lansdown’s Mark Dampier (pictured) echoes Buxton’s views, saying investors are too focused on short term catastrophes instead of on the compounding impact of staying in the market for the long-term.
“If I worried about everything everyone else said, I’d be a rabbit in the headlights,” he said. Dampier also said the headlines are ignoring the fact that there’s already been a market sell-off, but it’s been hidden in mid and small caps rather than the FTSE 100.
“There’s profit taking now but it’s disguised because it’s in mid and small caps,” he said.
While Dampier says there could be a correction in the near term, he would view it as a buying opportunity rather than a reason to run.
“Over the years we’ve had several corrections, but each one’s been a chance to buy in rather than a time to sell out,” he said.
However, Dampier does say the market may not be pricing in the impact of a yes vote in the upcoming Scottish referendum, which could cause a short term dip.
"A yes vote in the Scottish referendum could cause a correction,” he said. “I don’t think it’s priced in the Scots would leave.”