Market volatility affects profits and risks, which makes it inherent to financial markets. Considering the 2020 events and looking ahead at 2021, understanding its causes and implications is essential.
Even though market volatility is a concept frequently used in financial news and analysis, providing a definition is a first step towards acquiring a proper understanding of its meaning. Market volatility or financial volatility are notions employed to measure the variation of prices, rates of return, and interest rates of financial assets. If the price of an asset changes either rapidly or significantly, such an asset is said to be very volatile. Thus, the term is typically associated with market risk, which in turn could be defined as the negative effect that variations may have on a particular position.
Standard deviation is among the most used statistical tools to measure market volatility. Standard deviation measures the dispersion of prices and returns as compared to their historical means. A higher standard deviation means considerable fluctuation and a wider spread of numbers. There is another tool that allows investors to keep track of the US stock market’s volatility: the Cboe Volatility Index, or VIX. The VIX is calculated by Chicago Board Options Exchange (Cboe) Global Markets considering the behavior of S&P500 30-day options prices.
Often referred to as the fear index, higher VIX levels denote greater nervousness among investors and other market participants. Its current value is around 20. If compared to March 2020 peaks of 80 points, it is a relatively low value. Similar peaks were only seen during the 2008 crisis.
To achieve a thorough comprehension of the index, it is necessary to understand how options work. Options are financial derivatives that confer the right to sell or buy an asset on a future date at a specified price (called the strike price). In this case, the asset is the S&P500, and what distinguishes the VIX is that it is calculated based on options price variations for the next 30 days. When the VIX rises, uncertainty for investors during the following month increases.
Chart 1. Own elaboration. Data by Bloomberg
VIX behavior during the past five years can be observed in Chart 1. It can be easily appreciated how, during March 2020, market volatility levels reached a new record, and have not gone beneath 20 since then, keeping the index on a new scope. This degree of market nervousness has surprised no one: due to the pandemics, last year has been atypical at multiple levels.
Nevertheless, it is worth noticing that the first quarter of 2021 shows similar levels of market volatility, which will undoubtedly continue to be a driving force. Even though many had thought that the vaccines’ release and vaccination campaigns would inject optimism into markets, sooner than later new variables started to make an impact.
Countries with low economic growth rates, for example, have been greatly affected this year, and this is starting to show. Many governments have indebted themselves to face the effects of the pandemic. This is why last November’s optimism seems to have vanished.
Also, as an economic rebound is expected to take place, it is believed that inflation rates will increase. Subsequently, many investors have retreated from their positions in long-term public bonds, which in turn has caused a rise in their yield rate, led by the US Treasury. For emerging economies, this has been even more noticeable: the rise in bond rates was combined with currency depreciation.
What should we expect for the rest of the year? The progress of vaccination campaigns is an element to pay attention to since it remains a source of uncertainty for the world’s economic recovery. High fiscal deficits are another key factor that will put pressure on the public debt markets and, in the case of emerging economies, on their currencies. US stocks are far from calm, as can be seen in Chart 1. Meanwhile, a burning question about IT companies remains unanswered: For how long will they keep on growing? How will the change of home office trends and the reopening of schools affect them?
2020 was a volatile year, but 2021 is following close behind, probably with not-so-spectacular spikes. These first months have shown that market volatility remains at high levels.
This report was made by Gandini Análisis for SupraBrokers only as content. It shall in no case be considered as an investment recommendation.
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