Top 2014 Trends: Waiting for Volatility

In a survey, two thirds of respondents said that historically low volatility levels had made investors either too complacent or much too complacent.

For stock market investors, it has been another good year. But for Wall Street, the continued low-volatility, low-interest-rate environment has made profitability a continual challenge.

With the exception of a brief period of volatility in the middle of October − a month that has historically seen some epic shifts − volatility has remained exceptionally low. The CBOE Volatility Index (VIX), a.k.a. the fear gauge of the markets, has so far had an average daily closing level this year of 14.01, and that includes the high-volatility period in October. Thats far below its historical average daily close of 20.0 dating back to 1990.

The prolonged period of low volatility and low interest rates may be taking a toll. In a volatility survey conducted over the summer by agency-focused brokerage ConvergEx, two thirds of respondents said that historically low volatility levels had made investors either too complacent or much too complacent.

When will volatility return? As U.S. stock indexes continue to hit all-time highs in 2014, investment professionals have asked the questions endlessly, commented ConvergEx executive managing director Anthony Saliba, when announcing the results of the survey.

In one sign of complacency, the equity markets investors arent protecting their stock market gains by purchasing options, such as the ones that the VIX measures, according to the ConvergEx survey.

Another sign of complacency might have revealed itself during the high-volatility days in October.

Possibly caught off guard, three of the largest dark pools – those run by Goldman Sachs, Credit Suisse and UBS – temporarily told clients to send orders elsewhere when volatility spiked on Oct. 15, the busiest day for stocks in three years, Bloomberg reported. One unnamed trader who buys and sells shares across different venues said the three firms were not the only dark pool operators to experience issues on that day.

In the bond market, some view the situation as dire. With both volatility and interest rates in the basement, many firms have drastically reduced their corporate bond inventories. While regulations are partly to blame for low dealer inventories, many market observers also blame the lower risk appetites in a market where minimal volatility and low rates mean there isnt much spread to be gained. The double-sided challenge for the corporate bond market is that the low rates have sent huge numbers of investors into corporate bonds and issuance has been high, leaving many to wonder how bond investors will exit when volatility returns.

Several new electronic venues have launched in the corporate bond space this year, from Liquidnet, ITG, Bondcube, CodeStreet and, most recently, Tradeweb, in an attempt to make up for the lost dealer inventory. Still many doubt the inventory from electronic venues will be enough to plug the gap.

Its going to be an ugly exit, Michael Chuang, CEO of iTBconnect, a bond platform that connects bond market participants to multiple ECNs, told Traders. Its going to be a very ugly exit.