I was excited to see the Gerry Fowler presenting again at CBOE RMC Europe as I thoroughly enjoyed his presentation in 2013. Fowler is Head of Equity & Derivative Strategy, Global Equities & Commodity Derivatives BNP Paribas and this year delivered a presentation entitled Volatility Regimes and an Analysis of Where We Were, Where We Are, and Where We Are Going at the CBOE RMC Europe conference today. This most definitely could be considered one of the more timely presentations at this year’s conference.
He cites the credit cycle as being a major driver for different volatility regimes. A common theme among central banks is an attempt to target slower, less extreme credit cycles, which could have an impact on market volatility. He believes slow growth may continue until 2017 which could be interpreted as the US currently being close to the mid-point of the current cycle.
He covered how the four different stages of the credit cycle impacts credit, equity, and equity volatility markets. Focusing on equity volatility –
During de-leveraging volatility moves lower, the volatility of volatility rises, and skew rises as well. In co-recovery volatility, volatility of volatility, and skew all move lower together. During the re-leveraging stage volatility remains flat, volatility of volatility moves higher, and skew remains flat. Finally during a debt crisis volatility, volatility of volatility, and skew all move up in sync. He noted that the US is in the re-leveraging stage while the European markets are at the end of the co-recovery stage.
Some time was spent on the fundamentals of the US stock market. I knew that US companies had been aggressively buying back shares, but was surprised to hear the impact on earnings. Since 2010 revenues are up 20% for S&P 500 companies while earnings have risen 60% of the same time period.
Something else that I was very interested to learn was the relationship between low operational and financial leverage for companies and market volatility. When low leverage is being implemented earnings estimates tend to be more accurate and there are fewer earnings surprises. This reduction in earnings surprises lowers market volatility as well. It is an accepted fact that the stock market reflects market fundamentals over time, it is interesting to see the fundamentals show up in market volatility as well.
He finished up discussion how investors are rewarding companies that have low profit volatility. Stocks that have had low profit volatility have outperformed companies that show more volatility with respect to results. He went on to note that investor confidence has increased with respect to low volatility strategies so more leverage is being applied to these strategies.
Finally, during his talk Fowler cited two interesting articles which may be worth a read –
A Comprehensive Look at Financial Volatility Prediction by Economic Variables by Charlotte Christiansen, Maik Schmeling and Andreas Schrimpf –
Investment Risk and Performance – Risk Factors as Building Blocks for Portfolio Diversification: The Chemistry of Asset Allocation by Eugene L. Podkaminer, CFA –