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The Rise In Volatility
Submitted by Louis Gave via Evergreen Gavekal,
First it was the foreign exchange markets, then commodities, followed by fixed income markets. Now it’s the equity markets. Wherever we look, volatility has been creeping higher. To some extent, this is not surprising. At the end of the US Federal Reserve’s first round of quantitative easing, and at the end of QE2, the markets wobbled. So with QE3 now winding to a close (and with the European Central Bank (ECB) still behind the curve), a period of uncertainty and frazzled nerves should probably have been expected.
Nonetheless, viewing the recent market moves solely through the lens of central bank action (or inaction) may be overly reductive. After all, one can look at markets through five different prisms.
Growth: Apart from the US, which seems to be humming along, most of the recent economic data has disappointed. This is especially true in Europe and Japan, while China, following Beijing’s mini-stimulus this spring, is again undershooting expectations. Worse still, there are few reasons to expect Chinese, Italian, French or German growth to rebound meaningfully between now and the end of the year. Then there are the emerging markets that face significant headwinds, including Russia, South Africa, Brazil and Venezuela. All this contributes to a lackluster global growth outlook.
Momentum: We touched on the deterioration of European equities’ momentum earlier this summer. Since then things have got worse, with the Eurostoxx index down in nine of the 13 trading sessions following the ECB announcement of asset-backed security purchases. Even more worrying, negative momentum, which until a few weeks ago seemed confined to Europe, now seems to be spreading. The Russell 2000 is down for the year. So is Australia’s Securities Exchange, Malaysia’s KLCI etc...
Liquidity: Yesterday Charles argued that signs of a tighter liquidity environment are growing by the day, with credit spreads widening, the US dollar rising, the ECB’s targeted longer-term refinancing operations failing, random corporates going bankrupt (phones 4U), and breadth deteriorating rapidly in most equity markets.
Behavioral finance: The thrust of our work on behavioral finance is the notion that roughly two thirds of the time, a given market will act ‘normally’. The pattern of individual stocks within the index will be broadly chaotic and driven by many different factors: oil stocks will move with oil prices, banks will be affected by changes in the yield curve etc. Then one third of the time, markets will move into ‘abnormal’ state, when all stocks become correlated, with their performance driven by one factor (usually yesterday’s share price). In such an environment, adding value through stock-picking becomes almost impossible (but trend followers thrive). Today, an increasing number of markets are showing ‘abnormal’ behavior on our behavioral finance matrices.
Valuations: This is the big debate. With interest rates at zero, one can argue that equities everywhere remain massively undervalued, even though valuations in a number of markets (not least the US) are starting to look rich on a historical basis. Moreover, one can also argue that while an overall market (China, say, or Europe) may look undervalued, the undervaluation is the result of deep distress in a number of sectors (state-owned enterprises in China, banks/utilities/telecoms/oil in Europe...).
Putting it all together, it is hard to escape the conclusion that the environment for stocks is turning ugly: global growth is disappointing , liquidity and momentum deteriorating, and markets are starting to act abnormally. When you consider that September and October are often challenging for equity investors’ nerves, perhaps we should not be surprised by the recent wave of profit-taking.
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but its Friday and the end of the quarter is in sight...can't break down yet
The party is ending .
Who is going to be left behind on the Titanic ?
See https://www.academia.edu/8507311/Drowning_in_Gold
no way ... the band is still playing ... and there is free ice on the foredeck!
The ship CAN'T sink, because that would make the captain look bad!
crud.. bought some vol a couple weeks ago... maybe a little early
but if the SHTF i am good with that one.
In this falling EROEI environment, cb's will BUY everything they think is nessesary for the coming years, until 2020 at best. Until then, amazing circusses. Get used to it before the masses do.
"Growth: Apart from the US, which seems to be humming along,"
every "good" economic number 'seems' to have a curtain behind it ... and if you peek you'll find "oh, that's why"
subprime auto lending starting to go belly up ... and when it does there will be a pain train all along the (extensive) supply line.
"QE3 now winding to a close"
You must be pretty naive to believe that.
Just repositioning for QE4 I guess.
It's not really true that there's rates volatility. It's just the rates are so low, that a touch of a change is perceived as a large % move. That's the tricky thing in estimating vol levels.
VIX even at 10 seems reasonable (although I'd be tempted to go long vol) as realistic return from broad index should be 5-10%/year, either way. And historically, VIX (even at low levels) has been larger (reflecting option premium) than returns from the SP index.
ALL TIME HIGHS JUST AROUND THE CORNER!
This article is facile. The whole point of behavioural economics/finance is that people DO NOT behave in a statistically rational way. Consequently, behaving "abnormally" (quote, unquote) is, in fact, normal.
Second: What precisely does "we should not be surprised by the recent wave of profit-taking" mean? What were the parties on the other side of the transactions doing? Loss-taking? Whenever someone uses the term 'profit-taking' to explain a falling market, I know for sure that s/he is a fuckwit.
the fall in velocity.
Every now and then a very notable and important event occurs, sometimes it slips by without even being noticed. For months the major world currencies have traded in a narrow range as if held in limbo by some great force. This has allowed people to think we were on sound footing as central banks across the world continued to print and pump out money chasing the "ever elusive growth" that always appears to be just around the corner. Recently some currencies have made multi-year highs.
Weak demand for goods and most of this money flowing into intangible investments inflation has not been a major problem, but the seeds for its future growth have been planted everywhere. John Maynard Keynes said By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.
While there are not many Bond Vigilantes there are a slew of Currency Vigilantes and they are ready to make their presence known. Weakness in the value of the Yen, Pound, and Euro must not go unnoticed. More on why this may be a signal that currency trading is about to get very wild in the article below. Please note, this may also be sending a signal that the whole system is unstable and the stock market is about to drop like a stone.
http://brucewilds.blogspot.com/2014/09/caution-alert-currencies-may-get-wild.html