The market pendulum has resumed its violent oscillation
Volatility is back with a vengeance. The world’s big equity markets have taken most analysts by surprise in the early part of this year, when a rally across all sectors in these markets started and continued until early this week.
Granted, this upward move was supported in no small measure by a prolific infusion of liquidity over the past two years in markets across the US, the Euro Zone, and China, but still no investment report I am aware of, foresaw a 40% move in the Dow Jones Industrial Average, for instance. Then recently Japan joined the fray with a massive bond market intervention. This led to a major spike in the Nikkei, but during this week, the only evidence of the injection, was an index that shed as much on one day as it has gained the previous.
Similar performances manifested on other large bourses in the East, mirrored every day by enormous intra-day moves on Europe’s major exchanges, and eventually, also reflecting in trade on US markets. The attack in Boston lead to a brief contraction early in the week, but a day later US markets seemed to have shrugged off the impact only to be reversed a day later, leaving investors on the world’s largest stock exchange with a serious nervous tick.
Although trading during this week was exceedingly volatile, the VIX index failed to reflect the markets’ gyrations. Five years ago, the so-called “fear index” was on the radar of every analyst and every investor. During 2009 it shot up to unprecedented levels. The VIX index reflects a forward view as it is an indication of the “insurance” traders are prepared to pay for, to shield themselves against extraordinary market moves. But this comes at a price since it provides a type of cover against unforeseen losses and investors must be prepared to forfeit a small percentage of profits to pay for this spread of risk. Given the extreme volatility at that time, the spike in the VIX index was almost natural, but as conditions subsided, it returned to trend. This week, however, against expectations, it did not shoot into the clouds.
To me this is a sign that investors are not paying too much attention to the bigger picture. A rally is in progress in all major markets, and any trader not on the train, has missed it. Sure, several analysts asked the question whether this rally could last, but while the Dow Jones and the S&P 500 set new historical records, no serious investor dared sit on the sideline. But that complacency received a major jolt early in the week when markets contracted sharply.
This week’s events do not yet signal the end of the bull run as evidenced by the extreme ups and downs, but it certainly heralds a new period of volatility. I get the impression, investors have made peace with the pervasive uncertainty of the global economy and have started to accept it as part of the background noise. There are certainly a sufficient number of analysts who are not so enamoured by stock markets, but it is difficult to explain to a client why an investment position was missed when everybody else on the wagon is boasting of returns above 20%.
There is not a single model in the world that say at this stage, if the return of volatility is the first sign of the end of the rally, or if indeed, it is just a normal reflex to perceived problems, all of which are by now very familiar. The lack of a commensurate jump in the VIX indicates complacency across the board, but from my experience, it does not delay the neurotic response by investors that is often triggered by insignificant events.
Take for instance the massive liquidity injections by the Bank of Japan. I wrote about this shortly after the policy was announced, and admittedly, it led to spectacular gains in the Nikkei, but this week, every index point gained, was simply lost the next day. It is the Japan central bank’s stated intention to double its balance sheet within a year, and to ensure Japanese inflation picks up to one percent.
If this is not the pinnacle of insanity, then I believe there is nothing else that restore rationality to the markets. Perhaps this week’s volatility is the beginning of protracted contraction, or it signals the end of the rally, or, worse, it signals a period of renewed instability and uncertainty.
Commodity prices certainly did not escape the swings, and at one point I shuddered when I thought about the impact on our currency, and on our energy costs. In some reports, I find 2013 is considered a watershed year. Either we’ll slide into a morass of inescapable calamity, or we’ll tentatively start digging ourselves out of the massive hole we’ve dug over the past five years.