Wall Street is worried. But does it really have a reason to be?
The CBOE Volatility Index (VIX)—the so-called “fear gauge”—has had some rough sledding lately. After 15 months circling in a holding pattern in the 10-to-15 range, the line rocketed straight up to 37. Since then, it settled into another range between 15 and 25.
Some perspective. The only time the VIX was uncomfortably stuck above 30 for more than three straight months was during the Great Recession. Even then, it wasn’t until Lehman Brothers’ September 2008 meltdown that the VIX reached that level—kind of a lagging indicator. The VIX would double, reaching the 60s a few weeks later, and on a few days it reached a stratospheric intraday high of almost 90. And if you are curious, when the S&P 500 bottomed on March 9, 2009, the VIX closed at 49.
The VIX’s spike up to 37 last month was just that, a spike … a furious, although temporary event. It also occurred annually, like clockwork, in 2009, 2010 and 2011, then quickly became last week’s news as the slow, steady recovery progressed. Same thing happened in August 1998 in the middle of the dotcom boom. It actually dropped into the teens during the mini-recession that followed the tech bubble bursting.
Where is the VIX right now? It’s near the historical norm—so you see that we’re actually in pretty familiar territory.
Our agitation today is about one-third what it was when Hank Paulson and Ben Bernanke were trying to save the world. In other words, the VIX is right about where it was once we figured out they managed to do just that. It’s actually lower than it was most the time that any stock with “Web” or “e-“ in its name could expect a three-digit P/E ratio.
So why are so many people still so nervous?
The VIX tends to move in parallel with interest rates. As bond yields rise, there’s less of an incentive to take the risk of equity ownership when you can get solid returns with comparatively risk-free debt securities.
Bond yields rise in response to increases in the Fed Funds rate. The Federal Reserve resets this rate in anticipation of inflation. Raising the cost of borrowing reduces the money supply, so inflation can only erode the spending value of a dollar so far, or so the theory goes.
The Fed retains its 2% target rate for annual inflation over 2018. That’s low. To give an idea of just how low that is consider that inflation peaked in 1980 at 13.5%. Lesson #1 in getting a second term – don’t let inflation get to the double-digits your re-election year. That was all that was needed to end Jimmy Carter’s presidency. Candidate Ronald Reagan went on the air and asked America, “Are you better off than you were four years ago?” And that changed the whole political dialogue in this country ever since.
The worst inflation in U.S. history—Confederacy aside—occurred before we even had a Treasury. In November 1779, at the height of the Revolutionary War, the continental dollar reached peak inflation of 47% in a month. The definition of hyperinflation is price increases exceeding 50% per month.
So the United States avoided hyperinflation, but just barely. Countries that lived through hyperinflation in recent memory wouldn’t recommend it. For example, Poland decided on “shock therapy” rather than a soft landing when that country traded in communism for a market economy in 1989. It was worth it in the long run, but one cannot simply dismiss the pain of 600% inflation. It would’ve surely been worse if the International Monetary Fund wasn’t there to provide some cushion. And of course there’s Zimbabwe, the poster child for bad monetary policy. From 2006 through 2009, the Mugabe regime continually failed to learn any lessons, and the inflation rate during that period can only be rendered in scientific notation.
So when you take a long, historic view of U.S. consumer prices, you’re left with the inescapable conclusion that we’ve basically been spoiled rotten.
The initial read of U.S. GDP growth was revised down from 2.6% to 2.5%, suggesting that the economy is cooling down slightly faster than expected. Lending some shade to President Trump’s increasingly protectionist stance is that one of the drivers of the fall from 3%+ GDP growth over the rest of 2017 is a trade imbalance that shows the U.S. importing 1.13% more than it is exporting. The greatest negative impact, though, was a drop in inventory spending.
The S&P 500 steadily regained its footing after the first few trading days of February. At the lowest point of that dip, the index was down 9.5%, but ended the month down only 3.8%. As of this writing, the S&P is up almost 2% year-to-date.
The VIX index, which measures market volatility, has settled into a broad range, if not a steady state. As reflected in this month’s lead article, it is now consistent with historical norms rather than with 2017 long stretch of very low readings. This suggests that investors view equity markets with a typical dose of skepticism instead of over exuberant optimism.
Many stock watchers still maintain a favorable view of the economy but await the first wave of 1Q earnings reports before placing their bets.
European bourses have not bounced back as effectively as U.S. exchanges. Indexes in London, Paris and Frankfurt are down between 3% and 6% so far this year. Still, they don’t appear to be falling much further.
In Asia, the Nikkei is down more than 7% so far this year, but the Hang Seng and Shanghai indexes are right around where they started 2018.
Inflation fighter Jay Powell is now firmly ensconced in his new role as Federal Reserve chairman. Even he concedes, though, that his nemesis is likely to remain tame, with prices expected to rise at only around a 2% pace. Based on that, many analysts expect three or four Fed Fund rate hikes of 25 basis points each in 2018, and anticipate that pace of rate increases ticking up next year. Considering the U.S. Commerce Department’s recent report boasting 313,000 new jobs in February, the Fed will have the luxury to focus on inflation to whatever degree it impacts economic growth.
The Bank of England Governor Mark Carney has not been shy about his skepticism around cryptocurrencies. In a recent speech, he hammered home the point that the gyrating valuations of this new asset class constituted “speculative mania.” He called for greater regulation to “hold the crypto-asset ecosystem to the same standards as the rest of the financial system.”
Oil prices are up modestly so far in 2018 and have, uncharacteristically, proved much less volatile than stock prices.
The view from 2017 was that the dollar was going to slide lower against the euro in what was expected to be a fairly boring year for currency trading. The opposite, though, has proven to be true, at least so far. The dollar is gaining on both the euro and the pound as U.S. stocks recover more quickly than their European counterparts from early February’s disruption.
Bitcoin recovered from that inflection point, then kept going. Though still far short of its $17,000 record price from January, it stuck for quite a while in a respectable range around $11,500. Daily gyrations might be nerve-wracking, but its ability to regress to a mean cannot be wished away by skeptics. Even so, recent concerns related to the platforms on which the cryptocurrency trades have brought it down below $9,000. Bear in mind, that’s still $1,700 above where it was February 5, and $5,500 above where it was a year ago.