There is a lot of uncertainty in the market, but fear of missing out is causing investors to look the other way. August’s “Volmageddon” could be a sign of things to come.
In mid-August, the market’s seemingly endless uptrend was briefly halted. Most analysts attribute this to the unwinding of the Japanese yen carry trade (borrowing yen, which has historically had an extremely low interest rate, to invest typically in U.S. stocks or bonds) following the Bank of Japan’s interest rate hikes.
The resulting concern sent the VIX higher and the S&P lower, sparked numerous opinion pieces on whether this was the “big bang” and left David Elms, head of diversified alternatives at Janus Henderson, somewhat confused.
“If we look back at the recent past, people will be scratching their heads and wondering what this is all about,” Elms tells ISN. “The VIX hitting this intraday high was one of the three biggest spikes in its history – 2008, 2020 and August 2024. August 2024, unless something very strange happens between now and the end of the month, is the underdog.”
Elms essentially attributes this to a small accident in Japan that occurred at a time of year when seniors were on vacation and at a time of day when the VIX calculation was incredibly illiquid. Everyone thought that if the VIX was that high, “the world was going to end and rolled out their disaster plans.”
The parallel is probably the 2018 “Volmageddon” event, which saw VIX ETPs drop to virtually zero. Some time before the August event, the team at Janus Henderson saw VIX calls so cheap that it would “almost be rude not to buy them” and made a good profit on them in August, with bets against the dispersion trade also helping – although, as Elms notes, the month is not quite over yet. But while August’s Volmageddon may be a mystery, Elms expects there to be more events like it as the markets’ “uninterrupted, bumpy ride” comes to an end.
“The mispricing that creates a lot of opportunities hasn’t happened yet,” says Elms. “Now we’re starting to feel like that might be coming to an end as more geopolitical risks emerge and there’s uncertainty about monetary policy because there are signs of a recession. Things like that create a lot of opportunities.”
“As the strong equity and credit markets of recent years stabilize, alternatives will a) become more relevant to clients, and b) the opportunities for these alternative strategies will likely improve as well. In an ideal world, you’ll be generating returns for your clients at a time when they need those returns.”
The geopolitical events we have experienced have not distorted markets much, which Elms says is due to desensitization. A decade ago, a Chinese patrol boat ramming a Philippine patrol boat would have caused at least a minor hiccup in the stock markets.
“This scenario is probably the last straw,” says Elms. “Because we are numb to events in Ukraine and the Middle East, we are missing the reaction from markets that used to pay attention to this… It could be something that seems insignificant in itself, but pushes the world’s risk appetite beyond a comfortable level.”
For some investors, however, the difficulty is not recognizing that geopolitics is a risk, but how to manage that risk. The answer lies not in any single asset, but perhaps in understanding – in a practical sense, at the portfolio level – that good times do not last forever.
“Just because it’s difficult to trade doesn’t mean these things are irrelevant,” says Elms. “There’s a point where geopolitics becomes absolutely critical, and it’s very difficult to know when that point will come. What you need to do is protect your portfolio.”
“Russia hasn’t been attacked since World War II. Who knows how they’re going to react to that, especially if it threatens Putin politically? In the U.S., we have an election where a candidate is probably a slight favorite in the polls who wasn’t even a candidate a few weeks ago. There’s a lot going on and it’s easy to think that asset prices are constantly rising. But they’re not.”
