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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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Finally, shaken out of complacency .... or perhaps not.

February 26, 2020

 

 

ref :- "Investors remain complacent about virus despite sell-off" , Nouriel Roubini, Markets Insight, The Financial Times Markets and Investing

ref :-"Tail Risk" , Philip Stafford, The Financial Times Companies & Markets

 

Thankfully, things are a little calmer today. One would like to think that the markets are taking stock, giving themselves a chance to take a more measured view of exactly where we're at. The likely truth of the matter however is that they're waiting for the next piece of breaking news that will define their decision on which way to jump. This week's sharp falls in share prices in particular have been in stark contrast to the preceding period, which was marked by the almost total disregard of US stocks to the gathering storm clouds.

 

One man's resilience is another man's complacency, of course. It's true that US stocks have been able to recover from previous sharp declines in double-quick time in recent years and resume their inexorable rise to record highs, so it's not surprising if faith in the market has been hard to shake. But this time it's a bit different, isn't it .....and clearly Mr Roubini believes that the market's ability to remain impervious to the implications of Coronavirus until this week did indeed amount to complacency.

 

Such blind faith has been based on a number of flawed assumptions :

 

1. The epidemic would be contained mostly to China rather than becoming a global pandemic.

2. Having been contained, it would peak before the end of the first quarter , limiting economic damage to China and beyond.

3. The growth path would be V-shaped with a strong rebound in the second quarter and going forward.

4. Policymakers  --  both fiscal and monetary  --  would take strong actions to support economies and markets if required.

 

There are some academic disciplines where it's possible, sometimes even encouraged, to make almost any argument that is not yet a matter of fact so long as one argues it well enough. Amongst other positions, Mr Roubini is a professor at the Stern School of Business but we get the impression that  his reaction if any of his students had put forward the afore-mentioned assumptions on paper would've been pretty unequivocal, and expressed in thick red ink (a bit like our old physics papers)  :

 

1. WRONG !

2. WRONG !

3. WRONG !

4. WRONG !  --  Fiscal policy is a political football that takes far too long to implement even if the will is there, and monetary policymakers have very few bullets left to fire.

 

And so to the "Fear Gauge" .... you remember the VIX, the tradeable index of volatility derived from the price of 30-day options on the S&P 500 stock index ? It's measure that can tell us pretty conclusively whether the blinkers of complacency are being cast aside or not. Last week it was still trading below 15, historically-speaking a low level where it had been (give or take) for months. On Monday, it rose 47% to 25.03, its 7th highest one-day rise in 30 years. Yesterday it hit 30 at one stage. Even if its a bit lower today, it seems reasonable to say that finally Coronavirus has got Wall Street's attention.

 

That's not to say however that one couldn't make a case that many are still guilty of complacency. VIX futures prices are considerably lower than the spot price. The April expiry contract for example is trading at 19.10, suggesting that the market believes that the virus will be under control by the spring. Open interest numbers show that gamblers such as hedge funds etc are overwhelmingly "short" of VIX futures  --  in other words, they're betting against volatility. Well, it's been a largely profitable trade for a long time, but in these circumstances ?

 

Looking at the VIX futures prices, Philip Stafford does point out an interesting bump in price when it comes to the October contract, which closed at 21.95  --  September closed at 18.97 and November at 19.60. Remember, it's a contract based on option prices for a 30 day period and the October contract covers the upcoming presidential election. Obviously someone thinks its worth protecting themselves from volatility come election-time, and has been prompted to do so by the large lead being established by left-winger Bernie Sanders in the race for the Democratic nomination.

 

In principle, we can see why one might consider such action but frankly we've had the view for some time that for better or worse Donald Trump will cruise the election, so why bother ? But then again, perhaps it's us being complacent now .....

 

NOTE :  in the 2020 Presidential race, ODDSCHECKER offer Donald Trump at 8/13 , Bernie Sanders at 3/1, and Michael Bloomberg at 10/1. They actually offer ANY Democrat candidate at 11/8, which must rank as the skinniest price we've seen this year.

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