Friday, August 19, 2011

Mkt Weakness & The VIX

Everyone is talking about the VIX. The VIX this. The VIX that. What is the VIX telling us? What is the VIX?

The VIX is often misunderstood and wrongly classified as the ultimate fear gauge. It is an indication of market fear or investor angst but its just one piece of the puzzle. The VIX simply represents one measure of the market's expectation of stock market volatility over the next 30 day period. There has been money to be made playing market volatility over the last few weeks.

The move we have seen the last few weeks is different than what we saw last year.

In 2010 it took a good 2 plus months for the market to lose near 20%.

S&P 500 Down Move In 2010. Down 18%

S&P 500 Down Move in 2011. Down 18%

This down move was 2 weeks in duration. Like Justice in Texas. Swift and quick.

Many can make the point that S&P's downgrade lit the fire but this is wrong. The deficit ceiling freak show really alerted investors to how overtly reckless our Congressional leaders are. Cutting the deficit and shrinking government when the economy is clearly contracting and the consumer is in balance sheet hell is completely irresponsible. We are sowing the seeds of deflation. The market is taking its cue from the utter dysfunctional nature of DC. Couple this with the general flight to liquidity in Europe and what do you expect? There is also a flight to liquidity here as well as 10 Year Treasury bond yields are plunging.  A lot like 2008 right? Not really. In 2008 there was a general lack of certainty over what the government and policy makers can and would do. We saw markets crater and the VIX explode out. What we saw in the aftermath was bailouts galore and an opening of the liquidity tap. Now in the face of another round of economic malaise, investors are sure that policy makers will again bailout bankers and that liquidity will be ample. 

This can clearly be seen in the VIX Futures Curve.

The general fear of a full blown economic market catastrophe is largely being discounted if you look at the VIX Futures Curve.


Looking back at the longer dated VIX Futures curve. In 2008 the VIX spiked to almost 90 but the longest dated future VIX Contract spiked to only about 45. In 2010 we saw the VIX at 45 again the longer dated VIX Future spiked to about 35. Now we have the VIX at 43 and the longest dated VIX Future is at 29. So the fear going out is subsiding at each market interval. This is basically the market being more concerned short term rather than well into the future.

The Volatility markets are telling you or suggesting that markets are not going to see a precipitous drop like we saw in 2008. 

Is this not moral hazard on steroids? 

Now one can make excuses for the market weakness. S&P's downgrade, debt problems, earnings, jobs, slowing economy, Europe, China slowing down their economy, and housing. Guess what all of these are problems and have something to do with the general market malaise, but what I think the underlying cause is just the general failure of policymakers to make hard choices. This patch up the rotten to the core system is not getting it done. QE2 was and is a failure. This market downdraft in the US is the direct consequence of the Fed's distortion of risk markets. This idea of creating a wealth effect channel was a bailout for traders and speculators. It did nothing for the general economy. Nothing for the middle class. Nothing to fix the housing mess. Nothing to take on unemployment. When will this countries policymakers stop following the Neo Classical School for Economics? Supply Side is dead! Tax Cuts don't filter/trickle down. Markets are not free nor are they efficient. We have massive malinvestment into unproductive areas of the economy, mostly in the banking sector. Why are we surprised that the economy is getting soft right after QE2 ended?

When will the Fed, The ECB, and other Klepto Policymakers finally admit to the fact that their policies have mostly contributed not only to the weakness in risk markets but the general economy?

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