One byproduct of the recent tick higher in bond yields: a meaningful rise in volatility for both stocks and bonds. This volatility uptick was evident last week, though both asset classes rebounded on Friday after the April jobs report shifted expectations for a Federal Reserve (Fed) interest rate hike.
The VIX Index — a measure of implied volatility in U.S. large-cap stocks—rose to more than 16 last week, a one-month high. While this is still below the long-term average, volatility has jumped by roughly 35% since early May. Meanwhile, the MOVE Index — a measure of bond market volatility–jumped from 70 to 90, a near 30% move in less than two weeks.
Looking forward, the Fed is still likely to hike later this fall. As we get closer to a Fed rate increase, rates are likely to rise moderately, and volatility will probably pick up. As I write in my new weekly commentary, increasing volatility has an important implication for investors: It represents a headwind for many of the most popular momentum trades.
The “momentum” trading approach — buying whatever goes up the most — has been extremely effective for most of the past several years, as a low-volatility environment tends to favor this style.
But it doesn’t take much market volatility for momentum trades to unravel. Over the last few weeks, many segments of the market that have most benefited from momentum, such as biotech and social media companies, have been the hardest hit. For example, since peaking in April, the Nasdaq Biotech Index had fallen nearly 10% at its lows, a much more severe decline than the broader market.
The loss of momentum is having a predictable impact on investor sentiment; Last week, investors withdrew more than $11 billion from U.S. large-cap equity exchange traded funds, according to BlackRock fund flow data.