In my estimation, active Central Bank buying has acted as a volatility suppressant and equity/real estate and sometimes commodity market stimulant since Bernanke and Co. waded into uncharted waters in late 2008. As a reminder, we are 62 months since the acute stage of the Global Financial/Liquidity Crisis of 2008 and the Fed has been growing their balance sheet in 53 of those 62 months.
The Fed's balance sheet is approaching 4 TRILLION dollars.
Monday, for example the New York Federal Reserve pumped about $5 billion dollars into the market purchasing US Treasuries.
Talking heads/market pundits anticipate that the Fed will slowly reduce their monthly asset purchases starting anywhere between next week and spring of 2014. I feel compelled to point out that many market bloviators expected the Fed to step back in 2011 and many others "guaranteed" a Taper in September of this year (there are NO GUARANTEES in the market).
There are countless anecdotal/cautionary tales: It's much easier to start using drugs than to stop. Ask Rob Ford, Marion Barry, Marcus Aurelius, Jim Belushi, William Burroughs, Rush Limbaugh, Arthur Conan Doyle, Jerry Garcia, Sigmund Freud, Richard Prior, and Keith Richards. Just ask Keith. He knows.
Volatility is healthy and it's been artificially suppressed along with interest rates for the past few years. I believe 2014 will usher in a (welcome) return of volatility.
A quick look back at vol spikes:
- 2008 - needs no introduction. Cash VIX moved up to 90.
- November 2009 - Dubai World bankruptcy
- April/May 2010 - Greek riots and Flash Crash
- Summer 2011 - PIIGS bond blowouts, US Debt downgrade, MF Global implosion
- Early 2012 - French/Greek elections
- Late 2012 - US/Japan elections, sequester/fiscal cliff
- 2013 - Mini risk flares around Italian election, Cyprus crisis, Boston Marathon bombing/AP Tweet, and the "Taper tantrum" following 5/22 comments by Bernanke.
I don't believe the Fed can begin the Taper process without a natural mean reversion in volatility markets. 19-20% on the cash VIX is a rough mean.
The options markets have begun to express concern as downside skew (difference between OTM calls and puts) is becoming increasingly pronounced. (Red line = Skew reading; Blue Line = S&Ps).
Past performance is not indicative of future results, but the last two times put skew became this steep (May 2011 and March 2012) we had sharp equity selloffs (19% and 10%).
What would a reading of the 2014 Tea Leaves be without a quick look back. Here's some relative market performances over the past 12 months:
- US Equities are clearly the belle of the ball followed by European stocks
- High Yield bonds have done well (reach for yield) in a Zero Bound Rates environment.
- Agriculture has trended lower in 2013.
- Bonds (Treasury Long Bond) have performed poorly, especially since late May.
- Gold is the laggard in 2013 as markets anticipate reduced stimulus and slow growth with no inflation (Goldilocks scenario).
Enjoy the Holidays...... just don't sell too many S&P puts to pay for gifts because volatility could be lurking around the corner.