A reversal of recent low volatility in markets, paired with a rethink by global investors on the attractiveness of stocks, could have "devastating" effects, according to Gina Sanchez, CEO of Chantico Global.
Markets in the U.S. have ticked higher since the election of President Donald Trump, aided by promises of reforms, tax cuts and infrastructure spending. Meanwhile, investors have also diversified into other assets and have grown fond of trading volatility products to gain some extra return.
"If you consider the markets could get into a phase where they're rethinking what is happening," she told CNBC Tuesday, referring to the ability of U.S. lawmakers to push through new reforms.
"One of the elements that has been pervasive since the Trump election has actually been this incredible diversification effect that's been happening, meaning that pairwise correlations really broke down," she said.
Pairwise correlations refer to the average pair correlations between stocks, which is currently very low. Meaning, the average volatility of stocks is much higher than the VIX because it is getting diversified away. The VIX (CBOE Volatilty Index) benchmark measures the market's expectation of volatility over a 30-day period, and has declined significantly this year.
"So stocks were acting very idiosyncratically. So if you looked at the VIX it was quite a bit lower than the average volatility in the market because you had this diversification effect," she said.
"If that starts to unwind at the same time that the markets start re-rating, you're not just going to get a pop, you're going to get an even bigger unwind in volatility, and it could be actually quite devastating," she warned.
The asset manager is not alone in issuing such a warning to the market over low volatility. Deutsche Bank CEO John Cryan made similar remarks earlier in the month, and said that actual volatility could be "much higher" than is being priced in by the markets.
"The price of volatility is very low but volatility is actually higher," Cryan told CNBC in an interview.
He added: "So when you price an option – or when the market prices an option – it uses what is called implied volatility, so it's its expectation of future volatility. And that's been very low for technical factors by just buying and selling of futures and options. Actual volatility has been much higher, it just hasn't been reflected in those prices."