Wednesday, January 12, 2011

Fear subsides, equity prices rise

Yet again I post an update to this chart, which has captured quite well the underlying theme of the 2008-9 recession. The near-collapse of the global financial industry in late 2008 sent a tsunami of fear throughout the global financial markets and temporarily paralyzed global economies. Activity in many areas ground to a halt as consumers hoarded cash, institutional investors scrambled to sell risky assets, and everyone tried to deleverage. Fear was the common denominator, as captured by the Vix Index (the implied volatility of equity options), and it peaked in late October 2008. Equity prices continued declining, however, as new concerns were added, mainly the risk of a huge increase in future tax burdens caused by an unprecedented expansion of the federal government and a massive "stimulus" bill.

The past two years have been all about the unwinding of fear and the scaling back of the concerns over future tax burdens. Money has been "de-hoarded" to some extent, retail sales have recovered to their previous high, the economy is 18 months into a recovery, jobs are being added, industrial production is expanding, capital spending is rising, and federal revenues are growing at a double-digit pace, the Vix Index is back down to 16, only marginally higher than one might expect it to be during "normal" times, and Congress has a new mandate to sharply curtail spending and avoid new taxes. We haven't made a full recovery yet, but it is clearly visible on the horizon. The S&P 500 is only 18% below its 2007 high, but the CBOE technology index has already surpassed its 2007 high by 13%, and consumer staple stocks are only a few inches below their all-time high.

Two years ago the financial markets were priced to an "end-of-the-world-as-we-know-it" scenario. Today financial markets are beginning to realize that a return to "normalcy" is possible and within reach. We should all breathe a great sigh of relief.

Now, the Fed needs to realize this and plan its QE2 exit strategy ASAP. Otherwise we could find ourselves snatching defeat from the jaws of victory.


Benjamin Cole said...

What happened to Japan when they ended their QE efforts?

Scott Grannis said...

I think it is very difficult to draw parallels between Japan's QE and ours. As I've pointed out many times, Japan was suffering from a monetary deflation. Its currency had appreciated significantly--hugely--against every other currency and against gold and commodity prices. It was a massive deflation. When Japan halted its QE program in 2006, its currency was still significantly overvalued against almost all currencies, and commodity prices in yen were still severely depressed. Gold in yen was worth about half what it was worth in 1980. In short, Japan's QE never produced a meaningful amount of monetary inflation--it never reversed all the monetary deflation that had occurred in the years prior to QE.

The U.S. is in a very different situation. The dollar is very weak, and gold and commodity prices are soaring. There is no widespread deflation--deflation is limited to only a few sectors of the economy. We have had plenty of monetary inflation.

And of course, Japan's demographics are almost the polar opposite of ours. Their workforce is shrinking, ours is growing. Their whole population will begin to shrink soon, whereas ours will continue to grow for many decades at least.

Finally, Japan's fiscal policy makes ours look timid. Massive government spending programs have sapped the resources of the private sector for many years, and Japan's debt/GDP ratio is well into the triple digits. The national government has smothered the economy for decades with too much spending and too many taxes.

Public Library said...
This comment has been removed by the author.
Public Library said...

Bernanke and prior CB's are/were the largest sellers of volatility the planet has ever known. Levered on the backs of US taxpayers.

When this strategy eventually goes bust, the whole system will come crashing down.

The Fed keeps implementing this bailout strategy on an increasingly shakier and weaker base.

Good luck to all but you cannot fool the market forever, not even the Fed.

Benjamin Cole said...

Still, the record since Japan halted QE is not encouraging, and in fact, bond traders now expect at least another eight years of deflation in Japan. They seem caught in perma-recession.

Worse (and I am being a bit "soft" here), it seems to me the "energy" has shifted to S. Korea and China. Japan is headed to being a backwater nation.

I can't claim QE would have changed all that. But slow growth and mild deflation sure do not strike me as a good formula for a healthy, growing and vibrant economy.

One could even postulate Japan has a shrinking population because the economy is so gloomy--young people see no future, do not get married, have kids etc (which is an act of faith, as all of us who have or had families know).

I would much, much rather that the Fed err on the upside, and we get a little too much inflation, and lots of growth, than the Fed err on the downside, and we get price stability and little growth.

The results in Japan of low inflation-deflation are spooky.

China and Korea, on the other hand, have moderate inflation and robust growth.

Let's join Korea and China, I say.

Jeez, what is wrong with some old-fashioned boom times, growth and moderate inflation? The 1990s I liked.

Let it rip.

Benjamin Cole said...

BTW, this is a fun little service that ranks the ratio of positive to negative headlines in the WSJ. A type of leading or coincident indicator.

Public Library said...


All you need to know about real estate from a free market real estate investor.

Summary: the Fed and Government are your problem, not part of your solution.

Benjamin Cole said...


The Hayek-Mises-gold fetish crowd just does not appeal to me.

Listen, since the world went off the gold standard, we have had the greatest economic boom of all time.

I could even venture that today, on the entire globe, the only people left in poverty are those living in repressive non-market or corrupt regimes, or that do have have good work ethics.

Silver has ralled more than gold this year. So has palladium. How about silver-backed currencies? It just gets more nutty the more you think about it.

Friedman was against the gold standard, said it resulted in men rooting around like moles, instead of acting productively.

Frankly, right now we should be dumping currency onto the sidewalks of lower-income neighborhoods in the dead of night. That would stimulate demand, reviving our economy.

Show me a c-note, and I will work.

If I have a reservation about QE, it places cash in the hands of people who might not spend or invest it anyway.

My other idea is a national lotto, that pay out 200 percent of bets taken.