Just yesterday we posted a letter written by Jeffrey Miller (here) where he eviscerated Central Banks for the lunacy of their policies which have created complete complacency in the markets. The problem, as we pointed out, is that the Fed has lost all credibility by repeatedly caving every time they hint at a rate increase and markets sell off the tiniest bit. This "Yellen Put" is what enables desperate pension funds to pursue extremely risky strategies like the decision by the Hawaii Employees' Retirement System to allocate $1.6BN for a "put-writing" strategy (see ""Selling Puts" - Latest Pension Strategy Is Truly 2006 All Over Again") or like the decisions we discuss frequently of pensions buying longer and longer dated bonds for no yield.
Right on cue, this morning the Wall Street Journal pointed out that "the past 30 days have been the least volatile of any 30-day period in more than two decades." In fact, they point out that only 5 days during the most recent stretch has the S&P 500 moved by more than 0.5%, which is the lowest since 1995.
The lack of volatility has left traders a bit uneasy but as Matt King, head of Credit Strategy Strategy at Citigroup points out, you can't fight the Fed:
“Everything feels distorted and unnatural; you know the source of that is the central banks but equally there’s nothing to stop them carrying on,” said Matt King, head of credit strategy at Citigroup.
As the WSJ points out, the danger is not so much complacency about markets, but complacency about central banks.
If the Fed offers free insurance, there is no point buying your own, which ought to keep the price of puts—that is, implied volatility—down.
Faith in how far central banks will protect against losses comes and goes, though. In market-speak, the Yellen put is less out of the money if a smaller price fall pushes the Fed to act. At the moment, investors seem to think the put is barely out of the money at all.
The lesson of the past seven years is that policy makers will step in every time disaster strikes. But investors tempted to rely on the central banks should note that disasters did still strike, and markets had big falls before help arrived. The time to buy insurance is when it is cheap, and for the U.S. stock market, that is now.
Yes, central banks, to this point, have stepped up to protect markets at every sign of "stress." The problem is that with each new step taken by the Fed they're running out of ammunition. At some point, there will be an exogenous shock that will end the madness and there will be nothing left for the Fed to do. When this happens, decisions like allocating $1.6BN of retirees' savings to selling puts and buying 50-year government bonds for no yield will seem foolish...but for now it's just another day.