Wall Street is poised to end one of its calmest quarters in nearly six years, with the recent quiet following a turbulent start to 2025 prompting many investors to remain vigilant for potential market fluctuations.
During the third quarter, the S&P 500’s one-month volatility, which measures the index’s monthly price fluctuations, averaged 10.8—the lowest for any quarter since the three months ending December 2019.
The stock market has steadily climbed to record highs as investors increased their equity holdings after April’s tariff-induced selloff, benefiting from a dearth of fresh negative surprises that suppressed volatility. With measures of market fear near historical lows, investors are cautious that a volatility spike may be imminent.
“There’s a natural floor for volatility. It doesn’t go to zero,” said Matt Thompson, co-portfolio manager at Little Harbor Advisors.
“We’re aware of our position in the broader volatility cycle, so the next move in volatility is almost certain to be upward at some point,” he added.
On Monday, both the S&P 500 and the Nasdaq composite index, heavy with tech stocks, closed near their respective record highs.
Historically, low volatility levels tend to last weeks instead of months. Periods of extended calm have often been followed by sharp increases, such as at the end of 2019’s fourth quarter before the pandemic-induced market crash and the third quarter of 2018 amid trade and economic growth concerns.
Currently, optimism surrounding large-cap stocks linked to artificial intelligence and confidence in the U.S. economy’s resilience continues to bolster investors’ risk-taking appetite in equities.
Nonetheless, numerous factors could trigger volatility: A potential government shutdown could disrupt a broad range of services as soon as Wednesday. Investors also await economic data that will shape the direction of interest rates.
With macro risks heightened, a shock similar to the yen carry trade unwind in August 2024 or the tariff scare in April 2025 would likely cause greater losses for investors banking on continued calm than any gains from extending the current lull in stock swings, Rocky Fishman, founder of Asym 500, stated in a note on Friday.
Indeed, Cboe data showed a rise in demand for protection last week, with the three-month skew—a measure of demand for insurance against a market drop over the next three months—rising more than other tenors.
An uptick in volatility could trigger selling by systematic strategies—rules-based funds that use volatility and momentum signals to drive buying or selling decisions.
The reduction in market fluctuations has led these strategies to increase their equity allocations to historically high levels. Deutsche Bank estimates suggest that a spike in volatility could prompt them to become net sellers of equities.
Deutsche Bank strategist Parag Thatte estimated these strategies manage about $1 to $1.5 trillion in assets, potentially amplifying market movements even if their size isn’t large relative to the overall equity market.
“They don’t start the moves, but their impact can be significantly more than one might expect given their size,” Thatte said.
Still, for many investors, the recent low volatility isn’t enough reason to hastily implement hedges, which might prove costly if market calm persists.
Matt Thompson of Little Harbor Advisors prefers to reduce equity exposure rather than purchase downside protection, as he waits for clearer indications that market volatility will rise.
Others suggest taking advantage of the market calm to acquire hedges to complement risk-on positions. “For those fully engaged in the AI-driven FOMO rally, the low volatility levels do provide an opportunity for protection,” said Tobias Hekster, co-CIO at True Partner Capital, a global asset management firm specializing in equity volatility strategies.
“You can stay with the herd but have a safety net when the music stops,” he added.
