There has been much talk about volatility and this week’s more than tripling of the VIX Index, a measure of near-term volatility expectations for the US stock market (the S&P500 Index to be precise). However, while most of the talk is about this being a bad thing, taking equities into correction territory, down 10% from highs, I think it’s great. Why?

Because investors (US in particular) had got lazy and far too complacent, about a host of things, seemingly expecting the good times to roll on . Suffice to say, the proverbial flightless egg-laying birds are home to roost and, as is often the case when the US sneezes, global markets have caught a cold.

Firstly, market volatility. This had been so low for so long, well below average, helping US equities trend higher and higher (+20% in 2017, with a boost from Trump), that most market participants had forgotten what it was to have a decent down day on the S&P of more than 2%, never mind the 4% we got on Monday.

Secondly, interest rates have also been so low, and central bank policy so accommodative (low/negative rates, QE), for so long that markets got jittery at the prospect of in inflation returning and rates needing to rise too high too quickly. Even though nearly everyone agrees they can’t stay around at historic lows forever.

Thirdly, much like interest rates, bond yields had been kept depressed so low for so long (thanks to central bank bond buying stimulus; prices up, yields down) that rises which began to really get noticed in early Jan (US 10yr Treasuries at 2.6%, closing on a 3% unseen since late 2013), began to once again offer better value than the dividend yields from now overvalued equities.

The trouble is that too many investors had been putting cheap money to work as if volatility, inflation, interest rates and bond yields would stay low, and the equity up trend would go on forever. Which as everyone knows is never the case. And when too many rush for the exit, accepting lower and lower prices….

So, as much as the return of volatility has been a shock, I’m a firm believer that this is the wake-up call US and global markets needed. To shake them from a slumber of bullish complacency. Forcing participants to take stock of the fact that, a decade post financial crisis, economic recovery is in fine form, inflation is returning and so are higher interest rates, even if we are unlikely to see 4-5% pre-crisis levels for a decade. But even a return to a 1.5% UK base rate at the Bank of England represents a sextupling from 0.25% historic lows. The US Fed and ECB back at 2% would mean a 8x increase. Making borrowing more expensive for business and consumers.

Not high rates, granted, but significant changes nonetheless from the lows we have evidently got far too comfortable with. And it’s the same with the VIX and volatility and the media scrum this week. We’d got so used to a low, even declining VIX, which got as low as 9.2 on 3 Jan. This was the lowest since 2007 and 1994, well below its 200-day moving average of 19.5 and a far cry from the panic highs of 60 amid the 2008 financial meltdown. So todays 30+ level equates to a major jump. Giving markets an understandable jolt.

But if this is what was required to give markets a shake-up, to avoid us melting up even higher, only to sell-off even harder further down the line, with even more value destruction, then I’m all for it. I think it’d be great if volatility settles at levels more akin to the long-term average. Because this should prevent a repeat of the excessive risk taking we saw in late 2017, which might return us to over-valued levels , with everybody jumping on the bandwagon for fear of missing out, pushing prices higher and higher, before…..pop!

Now I’m not saying I want equities to fall further, but a correction of 10% is healthy for the S&P, Dow, UK Index and DAX, and we may even have further to go. And I’ve been around long enough to know that long-term, equities tend to trend higher. Look at any long-term equity index chart. The important thing is that we get regular up and down moves, rallies and corrections, which take the cream off the top of a rising market, giving an opportunity for profits to be taken, fresh money to flow in and present short/medium term trading opportunities along the way. Something for everyone.

On the one hand, this week’s surge in volatility is bad, taking equities even further from recent record highs. That said it should only hurt if you were extremely late to the party, un-diversified and not using stop losses. On the other hand this week’s surge is a good thing; a welcome wake-up call, preventing us from an even bigger and more painful crash further down the line, and perhaps seeing a return to more orderly markets with their more regular ups and down and opportunities for profit.

A blessing in VIXguise.

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Mike van Dulken, Head of Research, 9 Feb 2018