Thursday, August 4, 2011

This qualifies as a genuine panic

Here's an update to a chart I featured last June. Today's plunge in global markets qualifies as a genuine panic, according to this measure of how pessimistic the market is, and how much actual deterioration in the fundamentals there has been. The chart takes the Vix index of implied equity volatility and divides it by the yield on 10-yr Treasuries. The higher the Vix, the higher the degree of market uncertainty and fear; the lower the yield on Treasuries, the weaker the economy is perceived to be. So a higher ratio is bad, and a lower ratio is good. This is almost as bad as the first European sovereign debt scare which struck in April of last year. The Vix is currently over 28, and the 10-yr yield has dropped to 2.46%, which is only a few bps higher than the lows it hit last October when the market thought we were in a double-dip recession.

However, as this next chart shows, the Vix is still substantially below its previous peaks, so the driving factor behind the increase in the Vix/10-yr ratio is the very low level of 10-yr yields, which decline like this only when driven by fears of an imminent recession. This suggests that the market is very concerned about the onset of a global economic slump, triggered by PIIGS defaults which cause such great stress among European banks that contagion effects ripple throughout the world. Are we finally on the cusp of "the end of the world as we know it?" I doubt it. We've survived worse situations.

UPDATE: Here's the top chart with today's closing values (Vix = 32, 10-yr = 2.42%). It will be very interesting to see whether this panic can be arrested if tomorrow's jobs numbers are decent.


Benjamin Cole said...

Ever good to read Grannis' sober and intelligent commentary.

That said, QE3 is looking better to me every minute. Along with a Fed that explicitly targets nominal GDP growth.

We are in new territory, at zero bound. The old bromides do not work.

Time to re-read George Gilder: What is important is not a vice-grip on the monetary supply and subsequent minute rates of inflation.

What is important is a system that encourages innovation, business investment and entrepreneurship and risk-taking. Low taxes on business.

A monetarily induced perma-recession will not encourage business formation and hiring. Deflation will not encourage borrowing and risk taking.

Strong economic growth and moderate inflation seem to go hand-in-hand, and have in every modern American period of strong growth.

I am a lot more interested in robust growth than maintaining a 1.5 percent inflation rate.

Right now, the Western world really doesn't have a choice. We need growth and inflation to liquidate debt ratios.

Or, we can move to the Far East.

Benjamin Cole said...

The 5 year bond yield is down to 1.14% and falling fast.

Seems to me any sentiment that there is inflation in the five-year picture has been erased.

We have a honking glut of capital. You can't even give your money away for free. As pointed out BoNY charges you to hold money.

Actually, right now you are better off putting the money under your mattress (if you have a secure home).

Your cash will be worth more in a year, and you won't have to pay fees to BoNY.

There is a little disintermediation problem, but hey--we will have whipped inflation.

Jeff said...

Freeze spending at current levels. Make current tax rate permanent. Freeze further regulation.

Then repeal health care, Dodd, and financial reform.

We do not need qe3. We need to become a nation that produces and saves rather than a nation that borrows and spends.

John said...

This panic is a direct result of Tea Party intransigence regarding new revenue. Pay the damn debt. Start now.

Donny Baseball said...

John is all wet. Get real. We couldn't pay for a year's worth of gov't spending even if we expropriated all the wealth of all the "millionaires and billionaires", that is tax them at 100% not of income, but of wealth.

Ben - No, not another QE! We debased the dollar enough, crimping purchasing power.

We've regulated this economy into a stupor ala 1933. Unless and until we eradicate deficit spending, cut taxes and roll back regulation, we're going nowhere.

Benjamin Cole said...

Donny and Jeff-

I agree with lower federal outlays, less regs, no Obamacare.

But read George Gilder. Being obsessed with minute rates of inflation is not how you build an economy.

You build an economy by rewarding business formation, low taxes on productive people etc. It is hard to be optimistic--start a business--when deflation is haunting the economic scene.

Also, consider japan, They have crushed inflation. They have a strong yen. They are also sinking back into the Pacific, and their flag is the setting sun, not the rising sun.

Yes, we need pro-business regs and taxes, but we also need an expansionary monetary policy.

Cabodog said...

Interesting research paper from Brian Wesbury posted today on his website regarding the panic:,-but-fundamentals-still-strong

Charles said...

The debt ceiling deal was a non-event. There was never any chance of default and the cuts in the Aug 11 to Jan 13 time frame are trivial.

The revisions don't amount to much either. Inflation was a little higher and productivity improvements were overstated.

That leaves Europe and Europe has the markets spooked. No one really knows how this will play out and what the consequences will be. It's not Greece, Portugal and Ireland because they are in themselves inconsequential. Italy and Spain are another matter.

McKibbinUSA said...

The news is all bad from where I sit -- now is a time for vigilance...

Kris Tuttle said...

Hardly a panic really, at least based on the stocks I follow. Many all had a big move up from Q1 to Q2 that was just not justified. Fundamentals were/are solid but not great/improving. So even without all the macro negativity we were due for a 10-20% correction in these growth stocks which is what we just got.

Not saying they will stop falling or snap into a V shaped recover like we saw back in 2009.

Even with the micro crash many of these stocks are up 3-4x from where they were trading in early 2009.

acrossthecurve said...


what would QE3 even accomplish? u want to see a 10yr rate at 1.5%, well then move to Japan.


you nailed it, repeal obamacare and Dobb Frank, with Bipartisanship and I think you could the stock marekt above 1400 by december, if not its more than likely headed down, QE3 or not.


there goes the 30/10 spread...

Jay Norman Davis said...

Scott, could it be that the rest of the world observes that the US political system can not do what is right for the country. That our politicians have so much hate towards each other that what is best for our country does not matter. THat we are becoming unmanageable. This seems a far cry from 9/11 when all were coming together.


Anonymous said...

Scott, could it be that the rest of the world observes that the US political system can not do what is right for the country. That our politicians have so much hate towards each other that what is best for our country does not matter. THat we are becoming unmanageable. This seems a far cry from 9/11 when all were coming together.

I think that's a little simplistic. The rest of the world doesn't really care if the US economy goes down the toilet as long as we pay our debts. There's a fundamental disagreement - unrelated to clashes of personality - about how to fix the problem. Democrats believe we need to raise taxes and spend like there's no tomorrow. The GOP thinks we need to rein in spending. Hatred has nothing to do with it.

Scott Grannis said...

I agree with Zhang. Partisanship is part of the way a democracy works. We are facing huge issues and huge divergences of opinion. One side wants more spending and higher taxes, the other side wants less spending and less intervention. We have gone so far off the track of fiscal responsibility that there is not going to be an easy solution, but I think it's clear that the right has the better approach and that approach is supported by the majority of the people. Whatever the case, these are going to be the key issues in next year's elections.

Cabodog said...

Interesting chat today with a relative of mine that works in a Senator's local office. The Senator is a Democrat and the story I got is that they are receiving many, many calls from registered Dems complaining about Obama's performance.

Scott, maybe you're right and that this will be the final straw...

Benjamin Cole said...

"One side wants more spending and higher taxes, the other side wants less spending and less intervention."--Scott Grannis.

I am confused--were you talking about the USA? Which party wants less spending and less intervention? I would like to vote for that party.

Was it the party that got us into a $4 trillion commitment in Iraqistan? The Medicare Supplement? The TARP? AIG? A tripling of VA outlays? The ethanol that is every gas tank in America? That balanced budgets through Reagan, Bush, Bush jr.

Or the party of Obamacare? Vietnam? Dodd-Frank? Higher minimum wages? GM bailout? Fannie and Freddie?

I would like to vote for this party of lower spending and intervention. It sounds neat. Where is it?

McKibbinUSA said...

Scott, regarding your last comment, tending to the current fiscal crisis may not wait until the elections in 2012, though you make a good point -- however, the outcome of elections in 2012 only adds more uncertainty into the calculus -- in the shorter-term, I hope instead that Congress and the states will consider carefully the merits of the balanced budget amendment that will be voted upon sometime this Fall -- I would add that if the markets endure a 10% plus correction (and I would not rule out an eventual 3,000 point plus drop in the DJIA), then the balanced budget amendment might be fast-tracked to avert default -- in the meantime, the ongoing political debate in the US leading to the elections in 2012 may only exaserbate the markets further -- the markets are becoming exhausted with the political debates and are looking instead, for dramatic changes...