The Most Important Thing Stock Market Investors Have to Fear Is the Lack of Fear Itself

Things have come to a pretty pass.  The advance may be growing flat.  I say stocks are risky.  But they say that’s old hat.  Goodness knows what the end will be...  (Apologies to George and Ira Gershwin.)

Before Rupert Murdoch’s organization took over the WSJ and Barron’s, the latter used to be a great source of unconventional thinking about matters financial.  Now, it’s more like another voice of the Establishment.  In that context, it was disconcerting to see a piece by Barron’s options columnist attempting to convince us that a low VIX (i.e., “complacency index”) is no cause for concern (LINK):

IF THE VOLATILITY INDEX IS HIGH, it often means that investors are too scared about stocks, and it’s a good time to buy them. If it’s low, as it is now, it is often a sign that investors are too complacent, and that smart ones should be afraid. But conventional interpretations aren’t always accurate. Now is such a time.

While the options market’s fear gauge dropped to 13.22 during the week, its lowest level since late June 2007, the VIX is behaving as it should when stock prices slowly grind higher. There is no more profound meaning in the VIX…

“The lack of crazy is notable,” says a top options-trading strategist. “Volatility has been low. The stock market has been up, and that jibes with conversations we’re having with clients who tell us they’re not worried.”

They’re not worried.  That view is shown by data this same column presents:


The top left chart shows that VIX, which over decades has averaged around 20, has hit a multi-year low (optimism), but that VIX futures (“out” months) refused to join that party quite as much.  This reprises a pattern seen in April 2012, marking the market peak.  The top right chart, the put-call ratio, is toward the lower (optimistic) range.  The bottom two charts show options skew.  The description of skew that Barron’s provides is a bit backwards.  Saying that higher readings are bearish is confusing.  Higher readings reflect fear.  Lower readings reflect a sunny view of the future.  Options pricing is currently skewed toward optimism.  Yet merely 6-7 months ago, when not a lot appeared different in the domestic economy, fear was much more rampant.  That was the optimum time to buy.  

When clients of money managers are not worried, they buy CCC-rated (low junk range) 10 year bonds at only a 6% interest rate, setting all-time records for insouciance by so doing.  They extrapolate an easy resolution to the “fiscal cliff” to the next political battle.  They no longer worry about the eurozone that was scaring them half a year ago has gone away, soothed by a strong stock market rally in the relevant bourses.  

But just because clients seee sunny skies in all directions does not mean they are not on Galveston Island at the beginning of September in 1900 (LINK).  (That’s not a prediction!)  Less apocalyptically, one may think of the NYC weather– changeable.  Today’s weather never predicts that of merely a few days ahead.  As with the weather, always either changing– or not changing– so with volatility.  Assuming that recent volatility can predict that of one-three month’s out is dubious logic.

A little-known fact is that the calculation of the VIX assumes a steady grind upward of stock prices to create a low VIX.  If stock-holders assumed a steady grind lower of stock prices, then high VIX levels would be normal.  Thus, a low VIX really does price in the expectations of both an upward-trending stock market as well as low price volatility along the way– a pleasant Southern California springtime of day after day of perfect weather.

In other words, a consummation devoutly to be wished.

There is nowadays such acceptance of the reputed power of the Fed to keep stock prices levitating indefinitely that numerous reluctantly-bullish comments are seen on Zero Hedge (a site for short-sellers).  Yours truly takes that to show capitulation- though it is not a short-term timing tool.

While I have been almost totally out of Apple stock for some time (as discussed months ago on econblogreview), I remain a moderator on an invitation-only online Apple forum.  In response to the anguished cries from the fans who cannot understand why AAPL’s P/E could be as low as it is, I point out that all that Apple has to do is deliver the goods.  It must continue to innovate and grow earnings and book value; the stock price will follow in its own way.

As with AAPL, so with the stock market as a whole.  The economy and corporate profits simply must continue to convince investors that company A, company B, etc. are likely over time to deliver cumulative dividends that exceed today’s stock price, and exceed it by enough to more than make up for interest earned on bonds or cash.  But the headwinds are mounting, as trillion dollar Federal deficits and trillion dollar Fed money-printing exercises cannot coexist for long with A) very low interest rates and B) an upward acceleration of economic activity.  Something’s got to give.  

Another mainstream media pro-inflation outlet, Bloomberg BusinessWeek, is already whining about a tax increase that barely qualifies as one, namely the resumption of the 2% payroll tax cut that was given to workers to goose spending (LINK):

The payroll tax holiday was never intended to be permanent; at a cost to the government of hundreds of billions of dollars, tax experts widely expected it to lapse. Already, it’s possible that we’re seeing the first impacts. The Bloomberg Consumer Comfort Index—which measures Americans’ views on the economy, their own finances, and whether it’s a good time to make purchases—fell to -34.4, from -31.8, for the week ending on Jan. 6. 

This is but a small part of the evolving deficit-reduction strategy, yet the pundits are worried, as the entire article discusses.  

What has happened to the American economy that from 1984 through 1993, it withstood one revenue enhancement after another, culminating in shrugging off– mirabile dictu!- a tax increase in the middle of a recession in 1990?  And then a tax increase in 1993 during what was felt to be a jobless recovery?  And then a steep jump in interest rates in 1994 as the Greenspan Fed tightened dramatically?

Assuming that no recession has yet begun, it is at least late in the business cycle.  The latest estimates available for GDP growth of 1% annualized or less for Q4 suggest that GDP in the U.S. grew at 1.8% last year, and that’s accepting the official “inflation” data as accurate.  It is widely believed that an economy is at stall speed when its real growth rate is equal to the sum of population growth plus intrinsic productivity growth.  With population growth of about 0.8% and an average productivity growth of 1%, then it appears that GDP in 2012 was at stall speed.  Of course, this is despite what the authorities consider to be supportive monetary and fiscal policy.  (Many of us wonder if “stimulation” really stimulates.)

Stocks are also quite high in the valuation range, per q and CAPE (LINK), though when it is late in the economic cycle, they should be priced conservatively to be attractive to new money:

With the Russell 2000 yielding well under 2%, after a decade of ownership starting tomorrow of the IWM ETF that tracks this index, perhaps an investor will have received $20 in dividends for every $100 invested.   That $20 would be subject to tax, whereas the $100 in the non-IRA investor’s bank account today is after-tax.  So, perhaps after 10 years, $85 of that $100 would still be at risk, after taxes on the dividends.  

More and more, stocks are looking trapped from a valuation standpoint.  Either the real economy takes off in what would seem to be an inflationary expansion, which would bring P/E’s down both due to more competition from bonds and from strategists foreseeing the next recession; or it continues to at best muddle through, presenting recession risk day after day.  

The Barron’s options column mentions June 2007, when stocks were “grinding higher”, and when the VIX was at current low levels.  Was that a time to buy stocks or lighten up?  Was the economy truly stable and predictable, or was it a mirage?

The increasingly forgotten asset these days by the media is not the stock market.  It is not AAPL.

It is gold.













12 comments to The Most Important Thing Stock Market Investors Have to Fear Is the Lack of Fear Itself

  • JB McMunn

    My favorite headline is from The Globe and Mail last month: “Greece gets new EU aid, declares ‘Grexit’ era dead”

    Greece is fine, Spain is fine, France is a mecca for business, Japan will print money to buy ESM bonds, the US will raise the debt ceiling, Obama plans to send military “advisors” to 35 African countries, derivatives are some ghastly multiple of global GDP, and a Black movie star from a hideously violent movie goes on SNL and jokes about killing White people then calls for stricter gun control.

    Bonds tanked after the Fed’s recent Open Mouth Operation, which people somehow interpreted as an event that will chase people out of bonds into stocks. Never mind that higher rates often draw people into bonds and away from stocks.

    It’s all good. Buy the dips, the rips, and everything in between because the Cassandras were wrong in 2012, proving that stocks always go up. The crowing of the permabulls in December was deafening. Asset managers took a beating for missing the move in stocks and capitulated, apparently forgetting that the market really can stay irrational for an incredible period of time.

    Every time I have my doubts I just think “negative real interest rates” and look for hard assets to buy.

  • A coherent brief blog post in its own right, JB. Well written!

    • JB McMunn

      Doc is there some way to contact you? Or feel free to stick a dot between jb and mcmunn and tack on the end.

  • Californio

    After more than 25 years as a subscriber of the WSJ, I bailed for 2013.

    Doctorx you a correct, not much left of the old WSJ, online its all adds, even the email alerts have multiple adds, and a rehash of info you can get elsewhere.

  • Californio: I bailed in 2008 after 30 years or so of reading every word of the WSJ day after day. I was one of the very few interns probably in the country in 1980 who read almost every word of Barron’s. Michael Burry (younger) and I! Of course, he’s done a tad better than I have.

    Robert Bartley, who ran Barron’s editorial section, provided my introduction to libertarian thinking.

    • dd

      i bailed on the WSJ and Barron’s several years back at about the same time. i then resubsribed for MTA/Subway reading on the way to work in late 2008 / early 2009, their reported for whatever reason seemed to have kicked back into high gear with the incredible increase in meaningful news flow, then i left NYC soon after and never bothered to switch the delivery address.

      both are inance garbage at this point, i’m just happy to have found sites like this one, this being my favorite.

  • Thanks again for the appreciation.

    And re my prior comment, of course Bartley was the WSJ editorial page editor, not that of Barron’s.

  • D

    Oil prices, the great market equalizer. Inflation is hearing up again in PPI while Christmas shoppers basically went on strike. GDP is no way beating inflation and we are shrinking as a nation. The ‘output gap’ is not closing and under Obamanomics may never do so. We keep adding more to SocSec et al, food stamps, and more programs. Taxes up on all.

    Where does the growth come from? More printing press phony baloney money QEternity? More spending by the Keynesian Klowns has done nothing but amp asset prices. Go watch the Stockman interview on YouTube just released by Mises. It’s all ponzinomics to the extreme.

    But real assets.

  • D: Presumably your last sentence was meant to say: “Buy real assets”.
    The metals are up big today. As per the last sentence of my post above, the bottom for gold/silver may be in.

  • [...] More and more, stocks are looking trapped from a valuation standpoint. Either the real economy takes off in what would seem to be an inflationary expansion, which would bring P/E’s down both due to more competition from bonds and from strategists foreseeing the next recession; or it continues to at best muddle through, presenting recession risk day after day.  [...]

  • Sam

    Thumbs up! to the contributors and commenters on this site. This is one of the few sites devoid of spin. As they used to say on “Dragnet” “… the facts, just the facts….” the truth speaks for itself.

  • [...] The Daily Capitalist, DoctoRX comments on the disturbing lack of fear in the equity markets at present, saying this lack of fear is exactly what the market should [...]