Low-vol stocks on Wednesday fell to the lowest level since May, with a 0.2% loss contrasting with a 0.4% gain in the S&P 500. (Bloomberg News)

(Bloomberg) -- The reckoning arrived for one of this year’s most popular trades.

Low-volatility stocks have gone wild in recent months, discovering the danger in the second part of their name and rattling investors who sought safety by sending $6 billion dollars to the biggest ETF that track them. Those flows have slowed as a measure of the group’s swings exceeds the broader markets, reaching levels not seen in 20 years, data compiled by Bank of America and Bloomberg show.

While analysts from firms including JPMorgan Chase have warned for months that elevated valuations have made the stocks vulnerable to a selloff, Wednesday’s slump in rate-sensitive stocks provided a stark reminder of the pains inflicted by the unwinding of a crowded trade. Utility shares, the biggest component of the low-vol universe because of a once-coveted dividend payout, fell for an ninth straight day as rising bond yields erode the allure of equity income.

“Selling begets more selling,” said Donald Selkin, the chief market strategist at National Securities in New York, who helps manage about $3 billion. “People did so well with those stocks earlier in the year and as the stocks start coming down, they say, ‘Get me out while I still have a profit.’ The perception can change rapidly, but now that’s the new mantra.”

Volatility is exploding in a corner of the market that’s normally insulated from swings as central banks question the benefits of more stimuli after pushing global yields to record lows. Utility, phone and real-estate shares have started to move in lockstep with the prospects for higher interest rates as the Federal Reserve moves closer to tightening this year. These stocks tumbled as much as 2.2%, a turnabout from the first half of 2016 when the groups led equity gains. 

Based on historic volatility over 60 days, low-vol stocks swung more than the market every day in the past two weeks. The group’s measure of fluctuations exceeded the S&P 500 by 14% on Sept. 22, a level that’s been surpassed only once before, in January 1994.

The run-up in the shares this year also pushed valuations in the once-sleepy realm toward records. The S&P 500 Low Volatility Index trades at 20 times earnings, in line with the broader equity gauge. The low-vol group peaked at a valuation of 22 times in July, when the utility stocks were 13% more expensive than technology shares that normally have among the highest valuations.

Low-vol stocks on Wednesday fell to the lowest level since May, with a 0.2% loss contrasting with a 0.4% gain in the S&P 500. Cleveland Fed President Loretta Mester and Fed Bank of Richmond President Jeffrey Lacker this week argued in favor of tightening monetary policy sooner than later. Investors see a 61% chance of the Fed raising rates in December, up 11 percentage points from a week earlier.

Utility shares were heading for their longest streak of losses since 2002, sliding 0.3%. The group, whose 6.7% loss in the third quarter was the worst since the bull market began in 2009, is down more than 7% during its nine-day rout.

The reversal is stark for the former market darlings. In the first six months, when the S&P 500 fell into a 10% correction and suffered a two-day selloff of 5.3% in June after the U.K.’s secession vote, low-vol shares and utilities rallied at least 11%, beating a 2.7% increase in the S&P 500.

An investor retreat from ETFs may have exacerbated volatility in these stocks, according to Bank of America. The iShares Edge MSCI Minimum-Volatility ETF, the most favored equity fund in the first half with cash inflows that surpassed $6 billion, experienced two consecutive monthly declines in deposits through September. The PowerShares S&P 500 Low Volatility Portfolio ETF saw investors pull $471 million last month, the biggest withdrawal in two years.

“Overcrowded positioning in low-vol stock ETFs may be one reason behind their significantly higher volatility,” equity-derivatives analysts including Nitin Saksena wrote in a note Tuesday. “This corner of the market could be susceptible to further capitulation if there is a significant shift in confidence in the effectiveness of central-bank policy that causes investors to re-assess the duration risk embedded in their U.S. equity portfolios,” the analysts added.

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