Market Complacency and the Search for a Catalyst

June 6, 2024

Source: Bloomberg Source: Bloomberg

As we approach the summer, one question that is gaining traction: what could spook this market? In today’s Chart of the Week, I assess the level of risk the market is pricing in by examining the term structure of volatility for an at-the-money (ATM) call for the S&P 500 Index. The maturities range from the end of May until December 2024, and I compare these to the levels observed during the same period in 2020.

In financial markets, volatility serves as a critical indicator of investor sentiment and market stability. Recent trends in the term structure of volatility, specifically ATM options, reveal a notable decrease compared to the level observed in 2020. Term structure volatility refers to the pattern of how implied volatility varies across different expiration dates for options. Implied volatility is a metric derived from options prices that reflects the market's expectations of future volatility.

The positive macroeconomic environment is one reason for these lower levels of volatility. Economic indicators increasingly point toward the possibility of a "soft-landing" scenario, with a strong labor market and lower inflation among other factors. This stable economic environment suggests that the market might be underestimating potential risks, as reflected by the lower volatility levels.

The chart tells us two things: first, volatility levels are much lower than in 2020, indicating a significant level of market complacency. Second, in the near term, volatility is subdued, with levels decreasing in mid-June and reaching the same level at the end of August.

So, what could potentially change this sense of complacency? The largest change is anticipated from October to December, which coincides with the election — a possible catalyst. This is evident from the chart, where this year’s election has added more volatility from the end of October to mid-December, when compared to the last election, which did not have such a pronounced effect.

Additionally, another significant risk looms, the potential underperformance of artificial intelligence (AI) technologies. Given the increase in popularity and high expectations in this area, any failure of AI to deliver as anticipated could be a large catalyst for market volatility. This concern is underscored by the fact that 41% of the companies in the S&P 500 Index mentioned AI during their earnings calls throughout the first quarter of 2024.1

Key Takeaway

The current market environment is marked by a notable decrease in volatility levels, reflecting a high degree of complacency. This complacency is largely driven by a positive macroeconomic outlook. However, as we approach the upcoming elections, geopolitical risks are expected to increase, posing a significant potential catalyst for market volatility. Uncertainty surrounding different policies, especially those related to AI development, could significantly impact market dynamics.

With few other known catalysts on the horizon, it will be interesting to observe how these factors influence market sentiment in the coming months.



1Goldman Sachs – Portfolio Strategy Research; 5/15/24

Tags: Volatility | Macroeconomics | implied volatility | Market expectations | Artificial Intelligence | Elections | Geopolitical risks

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