Don’t count on vol regime change – BlackRock quant

“This time next year volatility will most likely be low,” says Fishwick

BlackRock
BlackRock's co-head of risk and quantitative analysis warns of more episodes of market turmoil

Despite recent turbulence in markets, investors should not assume volatility will be higher going forward, according to one of BlackRock’s top quants, Edward Fishwick.

The firm’s co-head of risk and quantitative analysis, Fishwick said the market will see more episodes of turmoil – like that seen in the first week of February – but he also warned investors not to see volatility as driven by internal market forces or to conclude it is likely to settle at higher levels than in recent years.

“This time next year, volatility will most likely be low,” he said.

Without a change in volatility regime there would be no reason for investors to abandon popular trades such as buying market dips or investing in high-yielding illiquid assets, Fishwick said, except where firms are sensitive to mark-to-market losses or liquidity risk. 

Concerns are building about inflationary pressures and possible threats to growth such as threatened US tariffs, he acknowledged. “But until those sorts of things happen we are probably in a low-volatility regime.”

Fishwick was speaking at Risk’s Quant Summit Europe event in London on March 7.

Equity market volatility spiked in early February with one popular measure of implied volatility – the CBOE Vix index – making the biggest one-day climb in its history on February 5.

Many industry participants attribute the February episode to forces within markets, such as rebalancing of short Vix exchange-traded products and gamma hedging by dealers. Vix has since retraced to lower levels, but remains higher than its average in recent years. The episode has triggered debate about the longer-term outlook for volatility and whether the low volatility of recent years reflects macro fundamentals or other influences such as quantitative easing.

It has already unlocked some new opportunities for volatility traders, but it remains to be seen how long those opportunities persist.

“Low volatility is far more ubiquitous in history,” Fishwick said. “High volatility is less persistent and rarer.”

If you’ve been in this game 20 years you’ll think the world is a really volatile place. If you’d been in it 120, you’d think the recent past was a bit weird
Edward Fishwick

Looking at annualised volatility of the S&P 500 going back to 1872 and using a hidden Markov model to identify two regimes, Fishwick said markets had been in a low-volatility regime about four-fifths of the time, with a mean level of volatility around 10%. For the remaining one-fifth of that period, volatility had a mean level of 21%.

“If you’ve been in this game 20 years you’ll think the world is a really volatile place. If you’d been in it 120, you’d think the recent past was a bit weird,” Fishwick observed.

He also warned against putting too much weight on explanations of volatility that are based on the actions of market participants.

As one gauge of how far volatility is driven by fundamental concerns, BlackRock compared changes in the St Louis Fed Financial Stress Index – an indicator of broad market stress – and the probability of being in either a low- or high-volatility regime. Fishwick described the match between the two datasets as “beautiful”. 

“This is not endogenous, self-feeding volatility. This is exogenous volatility,” he said.

“Volatility is low because earnings volatility is low. It is super low because of low variance in [price-earnings] multiples. There is a fundamental story about why volatility is low,” Fishwick told delegates.

Volatility expectations are critical to investment decision-making, Fishwick said, pointing to the distribution of equity premium in low- versus high-volatility regimes. If the volatility regime is low, today’s equity markets are fairly priced. If it is high, they are very expensive, he said.

He also warned about the perils for investors of sharp moves from low to higher volatility.

If volatility is low but punctuated by irregular episodes of much higher volatility, investors have to perform well during those episodes, he said. Effectively, time is compressed so the investor’s through-time diversification is greatly reduced.

A long period of low volatility followed by a burst of high volatility can “crush” information ratios, Fishwick cautioned.

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