THE issue of the day is low volatility, with the FT leading on the issue, while Matt Levine produced an interesting counterpoint in his Bloomberg column. We remarked on another aspect of the issue a couple of weeks ago, that the great moderation seemed to be returning in the sense that the volatility of quarterly economic growth has been very low.Earlier:
Volatility, in the market sense, means two different things. On the one hand, it means the variability of past data; market movements have been centred around the middle of the bell curve, with few of the fat tails that were seen in crises. On the other hand, volatility is defined by the Vix, a measure of the premia that investors are willing to pay to protect themselves against future sharp market moves. Like any insurance market, premia drift downwards in the absence of big claims. As Mr Levine points out, the Vix only tells us that investors aren't worried about shocks in the near term. The Vix seems to behave rather like ripples in a pond after a stone has been thrown in the centre; turbulence at first, but after a while, serenity reappears.
If the Vix was the only measure of market complacency, there would not necessarily be much to worry about. But the signs of investor sang froid are manifold. Jeremy Stein, a former Fed governor, noticed them in a speech back in February 2013; lower credit spreads, weaker loan covenants and the rest. Richard Fisher, the Dallas Fed governor, told us yesterday that those concerns remained; in Texas, he had noticed that national banks were lending money on terms no local bank would be willing to offer. Lenders to Spain and ireland, who seemed to be taking a huge risk just two years ago, are now willing to accept a lower yield than those who lend to the US Treasury, supposedly the global risk-free rate.
The irony here is that the return of risk appetite is exactly what central banks have been hoping for in the last five years. They want companies to get access to credit so that they can expand their businesses and hire workers again. Companies have been doing very well in recent years, with US profits around a post-war high relative to GDP, but that has been built around a squeeze on labour costs; top line (sales) growth, as Mr Fisher pointed out, has been pretty disappointing. But as has been the case through the ages (and China is demonstrating now), cheap credit does not always get absorbed in economically useful projects; often it gets diverted to speculation. Indeed, speculation is usually the most tempting use for the money.
But while it may seem obvious that speculative excesses are building, it is downright impossible to predict when they will peak; throughout 1999, companies with ever-more-ludicrous business plans and non-existent earnings were floating on the stockmarket but the Nasdaq did not peak until March 2000. Even now, it is hard to say what event sparked the sell-off; there was a Barron's piece in early 2000 that showed many companies were bruning throuigh their cash piles but that may have been a case of post hoc ergo propter hoc....MORE
Climateer Quote of the Day: Volatility Edition (VIX)
