The post-GFC global growth story has been built on practices and policies that have suppressed volatility and – as we’re beginning to see – permanent suppression of volatility may be untenable. In fact, there is reason to believe that the volatility these practices and policies have squeezed out of the system will come roaring back. Practices and policies that suppress volatility include:
The Black-Scholes model suggests that – because volatility cannot be created or destroyed – the idea of a permanent low-volatility, upward-trending market is an illusion. The overarching lesson is that markets can either experience volatility as we go – with periodic ups and downs – or markets can suppress volatility to support a steady upward trajectory. The latter ultimately leads to painful losses, unless governments intervene to suppress volatility and prop markets back up.
And we have seen evidence of explosive volatility materializing in markets – only to be suppressed again by government intervention. As inflation takes hold, institutional investors are asking themselves how durable and how reliable that government intervention is likely to be. Especially now that we’re seeing a few cracks in this approach. Will the longstanding, steady upward climb in markets prior to the most recent drawdown give way to episodic downward slides or a more prolonged slide?