Learning to live with low vol

Realised US equity volatility has historically stayed low for remarkably long periods of time. Importantly, volatility does not follow a normal bell curve distribution. Instead of volatility having a single ‘equilibrium’ level, we believe it is better viewed as operating in different regimes: often low, sometimes high.

We find US GDP data form similar realised vol patterns to those of the equity market – and both regimes tend to be long-lasting. High equity vol regimes can be fleeting, with no echoes in the economy. It is the overlapping market and macro shocks that are the most fraught with potential systemic danger.

We are vigilant on potential vulnerabilities in the financial system but believe post-crisis regulation and periodic bursts of anxiety (eurozone woes, China scares, commodity slides) have kept asset froth in check. We do not see systemic risk as high but are on watch for any stealth leverage build-up.