• 142 days Could Crypto Overtake Traditional Investment?
  • 147 days Americans Still Quitting Jobs At Record Pace
  • 149 days FinTech Startups Tapping VC Money for ‘Immigrant Banking’
  • 152 days Is The Dollar Too Strong?
  • 152 days Big Tech Disappoints Investors on Earnings Calls
  • 153 days Fear And Celebration On Twitter as Musk Takes The Reins
  • 155 days China Is Quietly Trying To Distance Itself From Russia
  • 155 days Tech and Internet Giants’ Earnings In Focus After Netflix’s Stinker
  • 159 days Crypto Investors Won Big In 2021
  • 159 days The ‘Metaverse’ Economy Could be Worth $13 Trillion By 2030
  • 160 days Food Prices Are Skyrocketing As Putin’s War Persists
  • 162 days Pentagon Resignations Illustrate Our ‘Commercial’ Defense Dilemma
  • 163 days US Banks Shrug off Nearly $15 Billion In Russian Write-Offs
  • 166 days Cannabis Stocks in Holding Pattern Despite Positive Momentum
  • 167 days Is Musk A Bastion Of Free Speech Or Will His Absolutist Stance Backfire?
  • 167 days Two ETFs That Could Hedge Against Extreme Market Volatility
  • 169 days Are NFTs About To Take Over Gaming?
  • 170 days Europe’s Economy Is On The Brink As Putin’s War Escalates
  • 173 days What’s Causing Inflation In The United States?
  • 174 days Intel Joins Russian Exodus as Chip Shortage Digs In
  1. Home
  2. Markets
  3. Other

The Boredom Before The Storm

With all the surprising and/or disturbing things going on - Brexit, China's soaring debt, US/Russia/China saber rattling, the, um, unique US presidential race, the cyber attack that shut down big parts of the US Internet - you'd think that an unsettled world would be reflected in skittish financial markets.

Instead we're getting the opposite, with stock price movements becoming more and more placid as the year goes on. The following chart shows the volatility index (VIX) for the S&P 500 which, after some notable action in 2008 and 2011, has become ever-calmer, with recent readings comparable to the (in retrospect delusional) levels of 2006, just before the biggest financial crisis since the Great Depression.

S&P500 VIX Overview 2008-2016

What's going on?

First, during credit bubbles volatility normally contracts because enough new money is being created to provide pretty much everything with a bid. In other words, all the new liquidity being created by desperate governments has to go somewhere, so dips get bought before they can become dramatic and traders accept the placid present as the new normal.

Second, we're in an election year and the people currently in charge badly want their chosen candidates to win. So government spending is rising dramatically. The federal deficit is up 17% so far this year, but jumped 67% in August. This burst of new borrowing has given the economy its current "all is well, stay the course" gloss. A bit more on this from MarketWatch:

U.S. runs $107 billion budget deficit in August, Treasury says

The federal government ran a budget deficit of $107 billion in August, the Treasury Department said Tuesday, $43 billion more than in August 2015.

The government spent $338 billion last month, up 23% from the same month a year ago. Spending rose notably for veterans' programs and Medicare, Treasury said.

For the fiscal year so far, the budget deficit is up 17%. The government's fiscal year runs from October through September. The Congressional Budget Office estimates the shortfall for fiscal 2016 will be $590 billion, or about $152 billion more than last year.

And what does it mean?

The current financial market insouciance is no more sustainable than that of 2006 because it's caused by temporary factors that can't continue without themselves causing turmoil. Debt, for instance, can't grow relative to GDP forever...

US Debt and GDP

...and equity valuations have only exceeded their current levels thrice in the past century, each time with notable volatility following shortly.

Shiller P/E 10

So it's a safe bet that 2017 will be in many ways a mirror image of 2016. US politics will be decided if not settled, government spending will stop spiking, and equities will return - possibly suddenly - to more historically normal valuations. And rising volatility will once again become the norm - as it should be in a world this dysfunctional.

How to play it? VXX is an ETF that tracks the VIX - but only for short periods of time. So it's strictly a trading vehicle, not an investment. Shorting high P/E stocks is a longer-term way to bet on the coming mean-reversion of equities to lower valuations. Put options are a medium-term way to make the same bet with leverage. If we're heading back to the exciting days of 2008 (which we are) then all of the above should provide both thrills and trading profits.

And precious metals, because they attract fearful capital, should benefit from the coming anxiety spike. Last time around - after an initial plunge - gold, silver and the shares of the companies that mine them embarked on a multi-year run that made them the best performing assets of the decade.

 

Back to homepage

Leave a comment

Leave a comment