No reason why fear couldn’t join the other bubbles of recent past,…
Is the Fear Bubble Bursting?
There have been quite a few bubbles and mini-bubbles that have burst over the past year or so. A short list would probably include China; housing; oil; fertilizer; solar; dry bulk carriers; etc.
What about a fear bubble?
We have overshot on just about everything else, so maybe it’s time we overshot the whole business of overshooting. Fear and volatility have become so much a part of the everyday existence for those who work in the investment world that it is all too easy to take them for granted.
When I see a contract on Intrade that allows people to bet on the end of western civilization, then I’ll know things have gone too far. I haven’t seen such a contract yet, but I feel obliged to note that there is a contract for The U.S. Economy to go into a Depression in 2009, with a depression defined as “a cumulative decline in GDP of more than 10.0% over four consecutive quarters.”
Looking at previous bubbles, I wonder if the fear bubble is analogous to an oil bubble. You see macroeconomic events moving inexorably in the same direction day after day and you begin to assume the future is a predestined march down what looks like an unavoidable path.
On Monday, in Fear Is on the Decline, I talked about signs I was seeing that fear was already “starting to leave the markets.” The VIX has already fallen more than 15% from Monday’s close and there is a good chance it will be at least another decade before it sees the 80s again.
Roger Ehrenberg is out with another thoughtful piece, Is Volatility Embedded in the System for a Generation? In it, Roger paints a picture of a financial crisis receding only to the point that it exposes gaping fundamental holes in the economy, the substantial risk of a Japan-style deflation, and a Fed so determined to prevent deflation that their easy money policy leads to runaway inflation and ultimately some sort of cruel game of low growth inflation-deflation ping pong.
In such an environment, which I would not consider to be too far-fetched, Roger describes a VIX of 40 as the new 20 and predicts a much higher floor for volatility in the future.
On the other hand, I am reminded of a post I titled The Big Question for the VIX back on May 22nd when the VIX closed at 18.05. The big question back then, with a financial crisis raging, oil approaching 150, and investor anxiety on the increase, was why the VIX was below 20.
Just five months ago, which was the more unlikely scenario: crude oil at 60 or the VIX at 90? It’s hard to say, but suffice it to say that it would have been hard to find the appropriate strikes to even make such a bet back then.
In the last five months, cause and effect has flipped. Not too long ago it was oil prices that were driving estimates of future economic activity and volatility, now the economy is the cause and oil, volatility and the like are the effects.
One day of 900 points gains in the Dow Jones Industrial Average will not fix all the economic woes on the horizon. It just might, however, signal an end to the runaway bull market in fear.
