Why Investors Shouldn’t Trust Low Volatility

You can speculate on stocks going up or stocks going down, but you can also wager on how extreme the ups and downs will be. Investors who bet on calm have done stupendously well lately. As in a 180 percent return over the past year on the VelocityShares Daily Inverse VIX Short-Term exchange-traded note, which is one of the most popular vehicles for bettors on low volatility.

Trouble is, as the late economist Hyman Minsky observed, stability creates its own instability. People get overconfident in their investing savvy and overpay. Professional investors who thrive on volatility find it harder to make a living when markets are calm, so they invest with borrowed money to amplify their meager returns. That makes them as vulnerable to a price decline as any indebted homeowner; margin debt has grown as rapidly as stock prices since the 2009 market nadir.