Tuesday, December 30, 2008

The potential for a panic rally

This chart lays out the potential for a powerful equity rally. Implied volatility in equity options has fallen rather dramatically (though it is still abnormally high), which means that fear is subsiding meaningfully. I expect that fear and uncertainty are slowing being replaced by greater confidence, and at some point that will bring buyers back into the market. I've been arguing for some time that the problems we face are not due to a shortage of money, but rather to a shortage of buyers. Buyers went into hiding and sellers panicked as fear rose beginning in late September.

There is plenty of money in the system, but fear (or call it a lack of confidence, whatever) has led people to hoard the money. With cash money essentially yielding zero, the next wave of panic could be people terrified of holding too much, not too little, cash, and seeking to put that cash back to work in assets that have positive return potential.


Larry Peterson said...

Great blog, Scott. It's quickly becoming one of my favorites!

Interesting thought about the inverse correlation of the VIX & S&P 500 Index. These next four weeks should prove interesting--with perhaps a bear market rally & overshooting of the index--and your correlation, while probably not predictive, would at least be supportive of that thought.

Scott Grannis said...

Thanks. I keep thinking that one reason stock prices are down is simply the tremendous fear and uncertainty out there. Reduce those problems and prices almost have to rise.