In a World Full of Risk, Why Are Investors So Calm?By
The economy and markets of 2012 sport nearly as many risk factors as a Cialis ad: Four years into full monetary tilt, does the Federal Reserve much know what it’s doing, and should we grow to expect QE6? Can a recessionary, politically scattershot Europe apply a cordon sanitaire around the still very real threat of contagion? What will arrest chronically high unemployment and food-stamp usage here at home? What of that beyond-cliché fiscal outcropping: Do you take your tax hit now, or pray that January turns out OK? All this uncertainty makes you want to snuggle up to the warmth of punitively yielding U.S. Treasuries.
And yet at least one measure is telling us that the overall mood of the market has never been so sanguine. I like to read “Perception,” an indispensable monthly analysis by Leuthold, the Minneapolis asset management and research shop. Of all the jagged, funky charts still getting spooled out in the aftermath of the financial crisis, this one keeps grabbing my attention:
Can it be? Leuthold’s monthly Risk Aversion Index, which bakes together various credit and swap spreads, commodity and currency prices, and relative asset returns to offer a broad gauge of skittishness, is at a record low going back to 1980. That span includes the Crash of ’87, the rolling emerging-market contagions of the 1990s, and the multiple human and financial calamities of the past decade.
Another reading, the JPMorgan G7 volatility index, is at lows unseen since peak swell of the private equity bubble, when Blackstone’s Steve Schwarzman hoarded $40 crab claws and few suspected that Greece’s and Spain’s books were sautéed. (Speaking of a private equity bubble, don’t look now, but it seems like 2012 is staging a redux.)
How does this overwhelming calm jibe with the prevailing uncertainty of our times?
“The so-called Bernanke put—or, more accurately, global central bank put—is suppressing most of the risk and fear gauges,” says Leuthold’s Chun Wang. “And just about all asset classes, risky or risk-free, have been bid up.” Wang finds that low-fear backdrops like this historically last much longer than high-fear ones, and that increasing signs that housing and China are on the mend only add to the general chill-out.
It’s been a paradoxical climate for investors, who have seen the rather unique confluence of low economic growth with double-digit global equity returns—something that normally doesn’t happen in the absence of post-recession relief rallies and/or significant interest-rate declines.
Some are already conflating all this calm with complacency, warning that danger lies ahead.
Myles Zyblock, chief institutional strategist at RBC Capital Markets, worries that the market isn’t sufficiently taking into account the risk of an economic-policy debacle. In a note to clients last week, he plotted the Chicago Board Options Exchange Volatility Index (“the VIX”) against a policy-uncertainty index developed by Stanford University and the University of Chicago. The VIX, wrote Zyblock, appears to be “a coiled spring,” as the performance gap between the index and the policy gauge shows investors are too focused on rising home and car sales, improving unemployment, and other promising indicators, all while giving short shrift to big policymaking hazards. “A predilection for government can-kicking” hasn’t eliminated the risk stemming from the fiscal-cliff negotiations and other policy decisions, he wrote. “And, from our lens, the risk is large.”
In October, at Grant’s Fall Conference, Artemis Vega Fund manager Christopher Cole gave a presentation—contrarian, if you buy today’s calm—entitled “Bull Market in Fear” (PDF). “Imagine the world economy as an armada of ships passing through a narrow and dangerous strait between the waterfall of deflation and hellfire of inflation,” he wrote, in a slide adorned with vivid apocalyptic art. “Our resolution to avoid one fate may damn us to the other.” Cole then channeled Donald Rumsfeld to urge the audience to “hedge unknown unknowns and sell known unknowns.”
Dizzy? Blurred vision? Consult your doctor.