Volatility is here to stay, some investors wager

Renewed trade worries have many market participants positioning for more turbulence.

  • By Ira Iosebashvili and Gunjan Banerji,
  • The Wall Street Journal
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A growing number of investors are betting that markets will stay erratic as a renewed bout of trade worries roils global stocks.

In a sign that investors are shifting how they react to markets, some are abandoning “buy-and-hold” postures and pouring money into bets that would take the edge off a sharp drop in markets or profit from higher volatility. Others are trading more frequently to take advantage of increased price swings or backing away from assets that may be vulnerable to turbulence. Still others are warning clients about the possibility of big declines in their portfolios.

These types of approaches have been largely unpopular during the market’s decadelong bull run. Investors were happy to hang onto shares and tended to avoid keeping a large cash allocation or maintaining expensive hedges.

Now, many investors are convinced that an aging bull market, persistent uncertainties over global trade and growth will lead to more frequent eruptions of volatility. They point to selloffs that gripped markets at the beginning and end of 2018, as well as the swings of recent weeks.

“This is unlike any other time in the markets over the last several years,” said Don Dale, a founder at Equity Risk Control Group overseeing options strategies. “Bigger moves up in volatility and faster moves down…this will become more the norm.”

As markets have swung, some investors have turned to the relative safety of government bonds. They have sent the yields on 10-year U.S. Treasurys, which fall as bond prices rise, near their lowest levels of the year.

Other investors have shown interest in products that tend to profit when volatility rises. Assets held in those types of exchange-traded products hit a record $3.1 billion in May, according to FactSet data.

The same trend has made options on the Cboe Volatility Index, or (.VIX), popular. Options trading on the VIX recently hit the highest since February 2018. It is in sharp contrast to December, when investors didn’t appear to rush to hedges despite a brutal selloff across stocks and bonds in the fall.

It also has grown more expensive to hedge. Options pricing shows that it recently has been more costly to protect against declines in the S&P 500 (.SPX) than it was at the end of 2018.

Matt Thompson, managing partner at Thompson Capital Management, said he bought options on the VIX that profit if volatility jumps through June and has pared down the size of his wagers overall, anticipating more frequent swings in markets. “In general we’re using smaller position sizes than we did five years ago,” he said.

Many investors say they are growing accustomed to the violent swings in markets. Data shows that such jumps in volatility have grown more commonplace. The moves follow years of calm in markets as equities continued a steady grind higher, fueled by unprecedented monetary stimulus from the world’s biggest central banks. Now, some investors believe markets may be reverting to a regime in which market gyrations are more frequent.

Michael Crook, head of Americas investment strategy at UBS Global Wealth Management, which oversees $2.4 trillion in invested assets, has been conducting “fire drills” that prepare clients to keep calm during hefty market declines. The bank manages money for wealthy individuals.

“We do expect to see more volatility,” he said. “We don’t want our investors to be surprised if they wake up one morning and markets are down 10% in a month.”

One yardstick of market turbulence, the VIX, jumped at least 20% a record number of times last year, according to Dow Jones Market Data. This year, there already have been three such jumps through May, half the figure from all of 2017. Known as Wall Street’s “fear gauge,” the VIX recently jumped the most in a single day since October last week.

Candice Bangsund, a portfolio manager at Montreal-based Fiera Capital, has adopted a more “tactical and opportunistic strategy” to better profit from more frequent stock gyrations.

While she expects a robust U.S. economy to lift markets, persistent worries over trade and global growth are likely to spark periodic selloffs, she said. “This is not going to be a buy-and-hold period,” she added.

Some observers have attributed the greater volatility to issues with market liquidity—or how easy it is to dive in and out of stocks. In recent months, investors have been concerned about thinning liquidity across markets. Fewer buyers or sellers around can mean there is less of a cushion for large trades entering the market, increasing the chances that they will move prices up or down dramatically.

Investors and analysts said they are watching a number of geopolitical events ahead that could spur greater moves. Trade tension between the U.S. and China is lingering and weighed on markets Friday.

Meanwhile, the Trump administration ordered the partial withdrawal of diplomats from Iraq on Wednesday amid heightened tensions with Iran.

Bullish bets on VIX futures, which can be akin to a bearish stance on stocks, outnumber bearish ones by asset managers, Commodity Futures Trading Commission data show. Still, some observers expect volatility to recede. Leveraged funds such as hedge funds have ramped up bearish bets against VIX futures in recent months, the data show.

Even those investors that are positioned for more market gains have taken on more protection.

Frank Maeba, who works on quantitative portfolios at Neuberger Berman, increased options positions that benefit from a drop in markets as stocks approached highs last month. He has trimmed them only slightly, even though stocks are down nearly 4% from their peak.

“Everyone wants to buy the dip, but that dip can really extend,” he said.

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