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Didier St Georges, Carmignac

Danger for investors is not volatility but instability

Didier Saint Georges (pictured). Managing Director, Carmignac writes that the stockmarket plunge in February coincided with a surge in volatility indicators.

This encourages the idea that volatility is risk, and that the notorious VIX volatility index deserves its nickname the ‘fear gauge’.
Volatility is nothing more than a measure of variations around an historical average. Commonly used volatility indicators, such as the VIX, are simply those implicitly used by market professionals to price the stock index options that they offer. So, the VIX leaps when large numbers of panicked investors want to buy options to cover their positions. February’s spike in volatility was all the more noticeable because it follows a long golden period in which investors' high confidence was reflected in very low hedging requirements, meaning minimal, stable volatility.
So, what we actually saw was the ‘volatility of volatility’ being prodded awake. But this only really matters to traders, or armchair speculators who have been hasty betting on volatility's demise. The reality is that it is normal for markets, buffeted by numerous sources of uncertainty, to be volatile.
Since peaking in February, the VIX has returned to very ordinary levels. But that doesn’t mean risk has gone away.  The real market risk to an investor lies elsewhere, in developments on such a scale that years of accumulated savings could be wiped out. Remember the crash of October 1987, or when Iraq invaded Kuwait in August 1990, or after the Internet bubble burst in 2002, and of course 2008? These all had different causes. But what they all have in common was that apparently well-established balances had become destabilised.
So, what are the destabilising influences on markets' long and successful recuperation post-2008?
We can safely assume that central banks' extraordinary intervention has been the main reason for the markets' comfort since 2009.  So, their recent change in approach must be the number one destabilising factor. Central banks bought up USD11 trillion of financial assets since 2009, creating massive buying pressure on asset prices. This year the US Federal Reserve will now sell USD400 billion worth, and the European Central Bank will gradually reduce its purchasing to zero. This vast reversal is a serious risk of instability, especially in our over-indebted world.
Central banks' largesse since 2009 had another indirect consequence: the deepening of inequality between owners of financial assets – bonds and shares, who have benefitted greatly from the markets' rise, and mere workers, who have seen no improvement in their standard of living. Amongst other factors, his has contributed to the rise of strong protest movements - the outcome of Italy's recent election echoes Donald Trump's victory in the United States. These movements can undermine the economic openness on which business depends in favour of protectionism – which businesses hate.
Fortunately for investors, the big driving forces behind the markets are microeconomic (corporate health of companies) and macroeconomic (economic health of countries).  These are capable of overcoming the instability risks. So as long as the global economic engine is still firing on all cylinders equally, the markets should be able to cope with plenty of hypothetical threats.
But the next economic slowdown will bring the instabilities back to the forefront.

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