Market Tranquility is Sowing the Seeds of its Own Demise

Gillian Tett (Financial Times) and Joshua Brown (The Reformed Broker) discuss the lack of volatility in the financial markets in this CNBC video clip:

"Historically you are not rewarded for putting in new buying orders in risk assets when there's zero volatility. Historically you're rewarded when you buy during volatility. So I don't think this complacency is healthy and I don't think it goes on forever." ~ Josh Brown

For other video clips of the conversation and other views, go to The Reformed Broker. Zero Hedge presents its thoughts below. 

Market Tranquility Is Sowing The Seeds Of Its Own Demise

Courtesy of ZeroHedge.

(View original post here.)

The mainstream media is latching on to the idea that all is not well in the world of 'markets'. The FT's Gillian Tett notes that, as we have vociferously explained, almost every measure of volatility has tumbled to unusual low levels, "this is bizarre," she notes, "financial history suggests that at this point in an economic cycle, volatility normally jumps." But investors are acting as if they were living in a calm and predictable universe,"[Investors in] the options markets are not pricing in any big macro risks. This is very unusual."

In reality, as Hyman Minsky notes, market tranquility tends to sow the seeds of its own demise and the longer the period of calm, the worse the eventual whiplash. Tett concludes, that pattern played out back in 2007… and there are good reasons to suspect it will recur.

No matter what asset clas you espy, volatility levels are at or near record low levels (record high levels of complacency)…

 

 

In case you needed one more warning – the period from initial crash in vol to melt-up in vol was around 15 months in 2007, the current period since April 2013's crash in vol and the sustained low vol period is 13 months…

But as The FT's Gillian Tett notes,

This is bizarre. Financial history suggests that at this point in an economic cycle, volatility normally jumps; when interest rate and growth expectations rise, asset prices typically swing (not least because traders start betting on the next cyclical downturn). And aside from economics, there are plenty of geopolitical issues right now that should make investors jumpy.

But investors are acting as if they were living in a calm and predictable universe…

“There is no demand for protection [against turbulence],” observes Mandy Xu, an equity derivatives strategist at Credit Suisse. "[Investors in] the options markets are not pricing in any big macro risks. This is very unusual.”

Why?

If you want to be optimistic, one possible explanation is that the economic outlook has turned benign.

But there is a second, less benign possible reason for low volatility: markets have been so distorted by heavy government interference since 2008 that investors are frozen. One issue that may account for the pattern, for example, is that tougher regulations have prompted banks to stop trading some assets. Another is that ultra-low interest rates have made investors reluctant to deploy their cash in public, liquid markets.

And there could be a more subtle issue at work too: investors are so unsure what to make of this level of government interference that they are unwilling to take any big bets. Far from being a sign of sunny confidence in the future, ultra-low volatility may show that investors have lost faith that markets work.

In reality, nobody knows which of these explanations holds true; I suspect that government meddling and low interest rates are the key factors here…

And that is a problem… as Tett concludes…

while ultra-low volatility might sound like good news in some respects (say, if you are a company trying to plan for the future), there is a stumbling block: as the economist Hyman Minksy observed, when conditions are calm, investors become complacent, assume too much leverage and create asset-price bubbles that eventually burst. Market tranquility tends to sow the seeds of its own demise and the longer the period of calm, the worse the eventual whiplash.

That pattern played out back in 2007. There are good reasons to suspect it will recur, if this pattern continues, particularly given the scale of bubbles now emerging in some asset classes. Unless you believe that western central banks will be able to bend the markets to their will indefinitely. And that would be a dangerous bet indeed.

In the meantime, BTFWTF!!

Did you like this? Share it:
About Ilene

Speak Your Mind

%d bloggers like this: