Rational Markets

The VIX index – the index of implied volatility derived from ‘at-the-money’ options on the S&P 500 Stock Index – is now 15.64%. At the beginning of the year, it was 23.4%. That is, the level of volatility that option buyers on S&P 500 Index are willing to pay for. In other words, they do not think that it would be worth paying options premium for a volatility level higher than this. This level is low compared to history. Just to get some perspective, the VIX level reached 80% in October 2008. It is a good ‘rule of thumb’ that investors are too pessimistic when VIX is high and too complacent when it is low. It is very low now. It was only slightly lower than this in 2007. For this blogger, investors’ attitude towards risk is intriguing.

Only one explanation appears plausible to me: since policymakers have made sure that interest rates pay no compensation for risk, investors have concluded that there is no risk.

The top ten stock markets this year are, as of yesterday (12th March), Egypt, Venezuela, Colombia, Greece, India, Peru, Vietnam, Dubai, Turkey Russia (not necessarily in that order). Looking at this ranking today (March 13th) shows Hungary instead of Peru. The point remains unchanged, however.

You can draw your own conclusions as to whether this is a rational, considered investment stance. There are no right or wrong answers. Only profitable or loss-making answers and that too is known only with hindsight at the end of relevant horizons. These horizons vary for investors. In my book, investors’ preferences that have given rise to this performance ranking this year are myopic.

In my article in MINT published today, on the US payroll report, I have stressed the role that mild weather has played in the last three months in the US:

The average contiguous US temperature for December was 35.0 degrees Fahrenheit (F), or 1.7 degrees F above the 1901-2000 long-term average.

The average contiguous US temperature in January was 36.3 degrees F, 5.5 degrees F above the 1901-2000 long-term average—the fourth warmest January on record, and the warmest since 2006.

The average temperature in February 2012 was 38.2 degrees F. This was 3.6 degrees F warmer than the 1901-2000 (20th century) average, the 17th warmest February in 118 years. (Source: National Climate Data Center of the US department of commerce.)

Henry Blodget wants ECRI to issue a three-word report: ‘We were wrong’. The more people get audacious about dismissing calls for a recession, the more encouraged the pessimists on the US economy should be. The US economy is adding a good number of jobs in temporary jobs placement services and in ambulatory services under Healthcare. Real Personal Income and Spending growth rates are declining. So are orders and shipments for non-defense capital goods excluding aircraft. The behavior of retail investors in the 1990s and post-2008 is so  startlingly different that it is almost as though they and market commentators inhabit different worlds.

Complacency is back and well. Or, we live in a truly Orwellian world of capital market in America. Or, as always, it is a bit of both.

Humans do not learn from mistakes, yet the consistent and unfailingly repetitive demonstration of this trait still does not fail to impress this blogger.

This post originally appeared at The Gold Standard and is posted with permission.

One Response to "Rational Markets"

  1. sierra7   March 15, 2012 at 1:15 pm

    I too follow the vix….and am shocked, shocked! That it is so low…….but with no risk with lending outside to the common folk, why not have a stock market vix so low?
    We are definitely in a much different world than in the 1990's…..very much different!