What’s Up With Recent Market Volatility?

Where are all those "Keep Calm and …"reminders when we need them? It's been a rollercoaster ride for investors in the past few days, mostly focused on the stomach-dropping part of the experience. After a lengthy period of relative stability, investors have been seeing a stark reversal.

RBC Global Asset Management Chief Economist Eric Lascelles tackled the topic of the recent market volatility in his latest weekly memo.

“After a weirdly long period of extraordinarily stable and happy financial markets, the past few days have witnessed a violent reversal," he said. “Realized volatility has skyrocketed, future stock market volatility is now priced to be unusually high rather than unusually low, and the U.S. S&P 500 has shed more than 5% of its value over the past week."

What's not behind the “violent reversal"?

“It wasn't any sudden dose of bad news," he explains. “No wars, corporate bankruptcies, recessions or other major macro shocks caught the market by surprise."

Then what is, you might ask? Lascelles, in his own words, describes two categories for the sudden change:

• First, markets had been preternaturally calm for an extremely long time. Bursts of volatility do come along every now and again, and this one was well overdue in a purely chronological sense. The high level of complacency, optimism and dare we say greed lately on display also created a vulnerability.
• Second, the bond market had started to respond to the reality of tightening economic conditions, rising inflation and therefore central banks set to continue removing stimulus. The big increase in bond yields over the past few weeks, preceded by steady gains over several months, had started to dim financial conditions. The final straw appears to have been the U.S. payrolls report which revealed strong hiring but also stronger than expected wage growth (a negative for corporate income statements, and a hint about the late stage of the business cycle).

Want more details? Lascelles explains:

• It is unusual for stocks to be down at the same time that bond yields are up (they have risen over the past several weeks, if not the latest few days). A more concerning signal would be if yields declined significantly, too.
• In all of this, let us recall that the economic signal is still quite strong (if no longer accelerating as much as before), central banks are not obviously making any policy errors in raising rates, and stock market valuations do not look too badly offside in a structurally low interest rate environment. However, it is undeniable that the business cycle is fairly old.