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Can Increased Volatility Lead to More Capital Investment?

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Heightened market volatility

The US stock market (SPY) (IWM) (QQQ) is currently subject to increased volatility. The past two years have seen market uncertainty heightening to levels last seen during the flash crash of 2010 and the debt-ceiling crisis of 2011.

The CBOE Volatility Index (or ^VIX), a popular measure of the implied volatility of S&P 500 Index options, breached the 40 level on August 24, 2015, when China’s (FXI) stock market crash led all major world indexes (ACWI) (VEU) (VTI) to fall. ^VIX was at 13.8 as of April 27, 2016.

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Volatility impacts all investments

Volatility impacts all investments. Equity becomes risky, and bond yield spreads widen. Investors rush to commodities or safe-haven Treasuries. However, in the current environment, commodities are in a slump, and safe-haven Treasuries aren’t yielding anything either. Sovereigns in developed markets such as Europe (VGK) (FEZ) (HEDJ) and Japan (EWJ) (HEWJ) are in negative yields.

There’s also the fear of corporate credit tightening for businesses, as more and more bad loans surface in the wake of the economic slowdown. Citigroup (C) recorded a 32% rise in non-performing corporate loans in 4Q15 compared to 4Q14.

The loan books of Wells Fargo (WFC) and JPMorgan Chase (JPM) have also felt the stresses of increasing non-performing loans. These were mainly attributable to the energy sector. Fears of a contagion are also bound to impact lending in other portfolios.

The merger and acquisition spree and buyback trend that has kept companies occupied for some time now is also waning in the wake of tightening corporate credit conditions.

The light at the end of the tunnel

The only possible recourse for businesses under these conditions seems to be deploying cash into capital investment. When everything else becomes risky, investing in oneself seems like the safest bet. Volatility would then lead to increased long-term capital investment in the United States.

Though banks may have become wary of lending, corporate credit may serve as fuel to the US economy’s growth engine. We’ll discuss this next.

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