By Saqib Iqbal Ahmed
NEW YORK (Reuters) - After a turbulent start to the year, investors are betting stock market volatility isn’t going away anytime soon.
While tensions between Russia and Ukraine have been the most recent driver of stock market gyrations, many expect inflation, uncertainty over monetary policy and stretched valuations to keep stirring asset prices this year, even if geopolitical fears subside.
The Cboe Volatility Index, often called Wall Street's "fear gauge,” recently stood at 29, some 11 points higher than its historical median. Volatility futures at least eight months out show markets pricing increased stock market gyrations for much of the year.
Some 78% of U.S. investment professionals responsible for fund selection and portfolio construction anticipate a rise in stock market volatility in 2022, according to a recently released Natixis Investment Managers Survey.
"This is not just Ukraine ... investors understand that this is not going to be an easy year, " said Arnim Holzer, global macro strategist at Easterly EAB Risk Solutions, which provides risk mitigation strategies for institutional investors.
Plunging stock markets in the wake of COVID-19 shattered a long period of placid trading and took the VIX to an all-time high of 85 in March 2020.
While the VIX has retreated as stocks more than doubled from their lows, it has not closed below last decade’s median level of 15 in more than two years, one of several signs pointing to expectations of more market swings to come.
"We don't necessarily see new post-COVID lows for the VIX anytime soon," said Max Grinacoff, equity derivative strategist at BNP Paribas (OTC:BNPQY), who has been recommending strategies such as put options spreads, which are designed to offer protection against volatility.
The S&P 500 is down 8% this year after rising 27% in 2021, while yields on the 10-year Treasury are up about 42 basis points year-to-date in anticipation that the Federal Reserve will tighten monetary policy as it fights to tamp down inflation.
The gyrations haven’t been confined to stocks. The ICE (NYSE:ICE) BofAML U.S. Bond Market Option Volatility Estimate Index - a one-month measure of expected volatility in Treasuries - stands near two year highs, while corporate bonds have also slid.
Elevated stock market valuations pose another danger if volatility persists, investors said.
The S&P 500's price-to-earnings ratio on a forward 12-month basis stands at 25.5, a 38% premium to its 20-year average, according to Refinitiv Datastream.
The elevated valuations could make stocks more vulnerable to bad news, potentially increasing volatility, said Patrick Kaser, portfolio manager at Brandywine Global Investment Management.
"Anything less than an orderly outcome is almost certainly a downside scenario for equities," Kaser said.
Kaser is favoring stocks and sectors he believes will be comparatively less volatile, including chemicals, banks and healthcare.
Meanwhile, Goldman Sachs (NYSE:GS) analysts recommended investors buy call options, which target higher prices, on interest rate sensitive stocks including financials like Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC).
"Higher interest rates have been a key driver of equity market volatility in recent weeks," they wrote in a report earlier this week. "We believe it is important for investors to have rate-reactive instruments in their financial toolkit."
Not everyone believes higher volatility will persist. Analysts at JP Morgan said on Friday that markets have likely priced in monetary policy and inflation risks. They recommended investors buy bearish put options on the VIX that would increase in value if the index fell by July, a seasonally quiet period for volatility.
Others however, are betting calm won’t return anytime soon.
"I would be expecting still some months of volatility for all risky assets," said Antonio Cavarero, head of investments at Generali (MI:GASI) Insurance Asset Management in Milan, told the Reuters Global Markets Forum on Thursday.
"I probably am a bit more confident in the second part of the year, but from now until then, it probably is going to be a choppy ride," he said.
(This story refiles to fix spelling error in headline, no change to content of story)