Wednesday, October 12, 2011
This chart shows the fairly significant reversal in two indicators of fear that has occurred this month: the Vix Index (orange), and the 10-yr Treasury yield (white). The chart bellow combines these two into one, the Vix/10-yr ratio:
Obviously, something big has happened since Oct. 3rd, which marked the peak in the Vix/10-yr ratio and the recent low in the S&P 500. The Eurozone sovereign debt crisis has not been resolved, not by a long stretch, so what is it? Two things: 1) economic data that show the U.S. economy is still growing, and in fact might be picking up a bit after a very depressed first half (e.g., unemployment claims, private sector payrolls, rail shipments, capital goods orders), and 2) indications that the Eurozone debt crisis is not getting worse and might possibly have a solution down the road. Reason #2 might not sound very convincing, but I think it does mark an important inflection point. After all, as I have been noting for awhile, since markets were priced to an "end-of-the-world-as-we-know-it" scenario, then anything short of that, even just a hint that conditions might be sort of stabilizing or improving just a tiny bit, would have to be very good news in a relative sense.
In short, markets were braced for an outright catastrophe, and now that seems doubtful. That's not to say the future looks rosy—on the contrary, we still face strong headwinds and likely setbacks on the road to a painfully slow recovery. To really get optimistic, we'll need to see real austerity measures (such as those adopted by Ireland), tax reform (lower and flatter tax rates, coupled with fewer deductions and a broadening of the tax base), entitlement reform (e.g., a privatization of social security, higher retirement ages, and market-based healthcare reform), and central banks willing and able to take bold steps to reverse their quantitative easing as the demand for money falls back to its pre-2008 levels. That comprises my wish list of things to hope for over the next 2 years, and I think they are doable.
Posted by Scott Grannis at 10:09 AM