Tuesday, December 21, 2010

Fear subsides, prices rise

I must have shown this chart at least a dozen times since late 2008, but it is so important that repetition is justified. (Here is a post from May '09 as an example) The main message here is that fear was the key driver of the 2008-2009 recession: fear of a global depression, fear of a global banking collapse, fear of deflation, and fear of a huge increase in future tax burdens thanks to an equally huge increase in the size of government. Fear drove us to the brink of what was expected to be an awful depression, and the reduction of fear is putting us back on a growth track.

The correlation between fear (represented by the red line, the Vix index inverted) and equity prices that is evident in this chart speaks for itself. The Vix has now returned to its pre-recession levels, and equity prices are on track to do the same, though the S&P 500 will need to rise another 25% to recover its previous highs.

Fears have been assuaged relentlessly since March '09. Swap spreads narrowed sharply. Credit spreads narrowed sharply. Signs of a recovery displaced expectations of a depression. Public reaction to the stimulus plan was mixed. Obama's popularity began declining, and the implementation of his agenda started facing headwinds. The Fed took strong action to expand the money supply. Financial markets began healing instead of collapsing. Commodity prices and gold prices started rising. Global trade got back in gear. Since the recession ended 18 months ago, the economy has proven the skeptics wrong more than once, and the forces of recovery have been working steadily behind the scenes, albeit slowly. Housing stopped collapsing and started stabilizing. A sea-change in the mood of the electorate resulted in a huge change in the congressional balance of power; the private sector now has a friend in Congress, and capital once again is held in high regard. More recently, a major increase in tax burdens was avoided, and a gargantuan omnibus spending bill went down in flames.

Short-term interest rates have been essentially zero for two years now. Investors, faced with the steep cost of safety (i.e., accepting a zero return for the safety of cash) have been realizing that the risks were not as great as they once feared, and they have been slowly deploying their cash hoards. Fearful investors have climbed countless walls of worry along the way, only to see the prices of risk assets moving higher. Consumers have been slowly drawing down their cash hoards, with the result that retail sales have now made a complete recovery. The next shoe to drop will be when corporations begin deploying their immense cash hoards to fund expansion plans and new hiring.

 It's hard to see how this self-reinforcing process of recovery can be derailed.


brodero said...

Scott..you have been kick ass ever
since those dark days of 2008....

Benjamin Cole said...

I agree with this post.

However, Japan is the cautionary tale, and it could happen here, with the wrong policies.

In Tokyo they have whipped inflation and they have a strong yen.

And, in the last 20 years, they have increased their GDP by 15 percent vs. 150 percent in the USA. Their stock and equity markets have plummeted, and bond traders expect eight more years of Japanese deflation.

The Bank of Japan (their central bank) has wrecked the country.

Be wary of those calling for tight money and the need to fight inflation. It is a siren call, to wreck your portfolios and crush economic growth.

brodero said...

Beware of Ron Paul...

Unknown said...

I have a few questions about your blog but I am unable to log into your blog to post messages form my home computer and getting to use this one is something of a pain. If you have an e-mail address for public usage I would appreciate it if would please post it in your blog or send it to Pencil_Nebula@Yahoo.com.


Benjamin Cole said...

BTW, todays WSJ has article page c1 to the effect that a single trader have taken a postion cornering 80 percent to 90 percent of the copper in the LME warehouses, worth about $3 billion, and other traders have taken similar positions in other metals.

Be advised we live in a world where single traders have $3 billion to take a position in copper or any other commodity. The trader may have far more money; we only know he took a $3 billion position at this time. We don't know if this trader is coordinating with other traders.

We know that sovereign wealth funds can take positions in commodities. We know that Russia could take positions in the NYMEX, playing both ends of buy-sell transactions, with the goal of raising MYMEX prices, to which many real-world contracts are tied. We know this would be in Putin's interest to do so.

The upshot? Not sure what oommodities prices signal anymore. There are speculative, possibly they are manipulated. Unlike stock prices, it is legal to try to game commodities prices with planted news stories and the like.

The investor's name is B. Wary.