"And we sang dirges in the dark, the day volatility died." -
, in unison
"I actually find myself daydreaming about winning 'Dancing
With the Stars' on some days in the office. It's gotten to be
very difficult, when you depend on price movement to make a
living, and there is none." - Paul Tudor Jones
In the years to come, we may look back at this week's Fed
announcement as the day volatility died, at least in the collective
minds of investors. The powerful combination of new all-time highs,
above the 200-day moving average, and the easiest global monetary
backdrop in history has finally set investors completely at
Janet Yellen could do no wrong at the press conference. With
each and every assurance that she is indeed as dovish as we all
assumed, the market surged higher.
Inflation bumping up against your 2% target? Inflation data is
"noisy," said Ms. Yellen as the markets roared with approval.
Risks? "I don't see a broad-based increase in leverage or a
rapid increase in credit growth," said Ms. Yellen. Again, the
markets moved sharply higher.
And with deadpan humor, Ms. Yellen brought down the house with
this to say on the subject of speculative behavior: "There is some
evidence of reach for yield behavior. This environment of low
volatility is on my radar screen."
Another surge higher in the S&P 500 (
) would follow, as Ms. Yellen would not come close to acknowledging
any connection between the 5+ years of quantitative easing (QE) and
zero-interest rate policy (ZIRP) and this speculative behavior.
Therefore, the algos naturally inferred that further speculative
behavior and reaching for yield will not be an impediment to an
"extended period" of dovish policy. And besides, Yellen made it
clear that it is merely "on her radar" at this point, and is in no
way concerning to her.
Is Yellen's complacency on the level of complacency justified?
You be the judge.
- If the VIX index closes the month at its current level of
10.35, it will be the lowest monthly close in history.
- The ratio of the volume of equity puts to equity calls
(put/call ratio) over the past 10 trading days is lower than 99%
of historical readings.
(click to enlarge)
- The yield on junk bonds closed at its lowest level in
history: 5.24%. The 30-day SEC yield on the most popular High
Yield Bond ETF (
) with over $13 billion in assets is even lower, at 4.22%.
(click to enlarge)
From these charts, you can readily see that Ms. Yellen is
downplaying the level of complacency and reach for yield on the
part of investors. But should we really expect otherwise from the
chairwoman, as the Fed's stated objective is to drive asset prices
higher in support of their "wealth effect" theory? If she were to
ever acknowledge increasing risk in the market stemming directly
from the Fed's policy, this would most certainly derail that
But enough on the machinations of the Fed. What does this mean
for markets going forward?
Well, there's an old saying that "Markets don't crash from
all-time highs." There's some truth to this notion, as tops often
take time to build (they are a "process"), and you generally see a
period of higher volatility before a sharp decline ensues. Indeed,
in looking again at the lowest monthly closes for the VIX, you have
never seen an exact cyclical peak (20% decline following) in the
market coinciding with an extreme low level of volatility. For
example, in the last cycle, we saw the low in volatility occur in
December 2006, and the market did not reach its ultimate peak until
10 months later, in October 2007.
(click to enlarge)
That said, while we may not be at "the" top, this is not to say
that volatility will remain low forever and that we will never see
another correction again. As volatility is a mean reverting process
and the long-term average for the VIX Index is 20, we are more
likely than not to see an increase in volatility going forward, if
we look out more than just a few days.
(click to enlarge)
So while investors can certainly enjoy the serenity of the
moment, they should not assume that the current market conditions
in place today will be in place forever. For as Charles H. Dow
"There is always a disposition in people's minds to think that
existing conditions will be permanent. When the market is down
and dull, it is hard to make people believe that this is the
prelude to a period of activity and advance.
When prices are up and the country is prosperous, it is
always said that while preceding booms have not lasted, there are
circumstances connected with this one which make it unlike its
predecessors and give assurance of permanency.
The one fact pertaining to all conditions is that they will
change." - Charles H. Dow, 1900
At a tactical asset manager, we are constantly evaluating
underlying conditions as an integral part of our investment
process. Over the past two months, conditions have favored a more
aggressive stance, and we have been positioned as such in our
mutual funds and separate accounts. Prices are up and the country
is prosperous, and many seem to believe this will always be the
case, as there are "circumstances connected" with this boom (namely
the Fed and low interest rates) which make it "unlike its
We can all hope that this is the case, but having lived through
prior booms and busts, we should remain skeptical of this notion.
For our part, as a tactical asset manager, we stand ready to take a
more defensive stance when conditions inevitably change. Given the
broad levels of complacency we are seeing today, this change, when
it occurs, will undoubtedly be a shock for many.
This writing is for informational purposes only, and does not
constitute an offer to sell, a solicitation to buy, or a
recommendation regarding any securities transaction, or as an offer
to provide advisory or other services by Pension Partners, LLC in
any jurisdiction in which such offer, solicitation, purchase or
sale would be unlawful under the securities laws of such
jurisdiction. The information contained in this writing should not
be construed as financial or investment advice on any subject
matter. Pension Partners, LLC expressly disclaims all liability in
respect to actions taken based on any or all of the information on
The author has no positions in any stocks mentioned, and no plans
to initiate any positions within the next 72 hours. The author
wrote this article themselves, and it expresses their own opinions.
The author is not receiving compensation for it. The author has no
business relationship with any company whose stock is mentioned in
Don't Be Surprised When J.C. Penney Blows It Away
On Gross Margins