ClockWise: A look at the recent jump in volatility – are markets overreacting?

As fear spreads that monetary policy will remain tighter for longer, global equities fell over the week to their lowest levels since early June.

In August, equity markets had progressed into bull market territory and investor sentiment was euphoric as volatility fell to its lowest level since 2020.

Volatility has jumped higher over recent weeks though, in line with the seasonal pattern of the Volatility Index (VIX) rising into an October peak (Chart 1). Equities have performed well over most of this year but, over the short term, we would not be surprised to see further downside and for volatility to drift higher should the fears of higher interest rates, and resilient data, lead to a further set back in markets.

Spikes of volatility can bring about good buying opportunities for active investors and using investor sentiment can help guide asset allocation decisions; it sometimes pays to buy when others are scared. The recent pullback in markets and rise in volatility has arguably removed the froth from markets and taken investor sentiment away from earlier euphoric levels. However, sentiment remains far off levels that could be described as overly depressed. Last week’s sell-off could have further to go before this becomes an opportunity to ‘buy the dip’.

Chart 1: VIX has risen but usually peaks in October

Source: Refinitiv Datastream, Royal London Asset Management. As at 24 September 2023.

Chart 2: Royal London Asset Management’s composite sentiment indicator

Source: Refinitiv Datastream, Royal London Asset Management. Composite sentiment indicator includes factors related to market volatility, retail investor bullishness and US directors dealing in shares in their own companies. A reading of -1 or lower indicates a market panic and contrarian buy signal. As at 24 September 2023.

Market summary

Global equities fell over the week as comments from the US Federal Reserve (Fed) led markets to worry that policy will remain tighter for longer. The S&P 500 fell close to 3%, the largest drop since March, with growth stocks leading declines as yields rose in the US (10-year rates reached a 16-year high of 4.5% following the Fed’s decision to remain on-hold, together with strong labour market data). UK equities outperformed, helped by weakening sterling. In fixed income, gilts continued to outperform on softer inflation data and the decision from the Bank of England (BoE) to keep the policy rate unchanged.

Economics summary

Another set of downbeat flash Purchasing Managers’ Index (PMIs) data for September. European PMIs continue to look recessionary. The Fed kept rates on hold, as did the BoE after inflation came in lower than expected.

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