Volatility has ended the year at record lows, adding to concerns that complacent investors are sleepwalking into the next crash as stock markets around the world hit new highs.
The VIX Index, a widely-used measure of expectations of future volatility, slipped a further 21pc in 2017, finishing at an end-of-year record low of 10.40. In the past, low volatility has predated some of the biggest market collapses. According to the VIX index, also known as the Fear Index, volatility tumbled to an intraday low of 8.56 in November, its lowest level since the index began in 1990, while FTSE-100 volatility is also at an end-of-year record low at 9.56.
The last time volatility sunk to levels this low was in the run-up to the financial crisis a decade ago and volatility then soared to a peak of 80.86 at the height of the global downturn in 2008.
Markets have taken warnings of a possible nuclear war over the Korean peninsula, stuttering Brexit talks, and Donald Trump’s chaotic administration in their stride with the Dow Jones and FTSE 100 hitting multiple record highs this year. Global share prices have surged $9 trillion this year.
The FTSE 100 surged by around £141bn during 2017, according to the London stock exchange, while the FTSE 250 index of medium-sized companies gained around £52bn. Asian markets posted their best year since 2009, and European markets had their strongest performance since 2013.
However, markets could be “rudely awakened” from their slumber by political or central banking shocks in 2018, according to Accendo Markets analyst Henry Croft. The “extraordinary monetary policy measures” implemented by central banks in the aftermath of the crisis and, most importantly, several rounds of quantitative easing have underpinned the low volatility and helped stocks climb to record highs, Mr Croft said.
The FBI investigation into alleged Russian collusion in the 2016 US election “remains a dark cloud hanging over the Trump administration” and ECB tapering of its huge quantitative easing programme too quickly, could jump-start markets into life again, he said. Quantitative easing has driven investors out of safer bonds and into riskier stocks, keeping their prices inflated.
How does quantitative easing work?
The ECB will begin to wind down its €60bn-a-month bond-buying programme and the Federal Reserve started to trim its balance sheet of government bonds last October. With central banks shifting towards tightening policy and the global economy moving from disinflation to inflation, it is “unlikely that UK equity volatility can remain rooted so low in 2018”, according to Jefferies global equity strategist Sean Darby.
The progress of Brexit talks remains a key catalyst ready to ignite markets, analysts said. Mr Croftsaid: “Brexit remains the big uncertainty for the UK economy.
Fears of recession have so far proved unfounded, but until the final form of the UK’s divorce from the EU emerges no one can be sure of its impact on Britain.”
A study of 40 financial bubbles by the Swiss Finance Institute earlier this year found that in 65pc of the cases when they popped volatility was subdued. However, its analysts concluded that volatility is not a “reliable indicator” of a stock market crash.
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