There is a smell of burning coming back to the financial markets. It seems that yet again the market has decided to focus its attention on the likelihood of the Fed tapering down the stimulus it provided. We are now all waiting for the dreaded NFP release again. But hold on a moment ! where is the logic behind all of this sudden short-termism embraced by market makers and speculators? Surely the FOMC has better and more real time access to economic data than we have ? if they decide to taper down it is likely that their view is that the economy is improving. Surely things are getting better, At 7.5% the US unemployment is at its lowest in the last 4 years and exporting companies have thrived on a weak dollar . True the last few days have been a bit incisive for any equity portfolio but overall the year to date performance remains excellent.
1-month performance of global equity markets
6-month performance of global equity markets
Personally I would not bet on one Non Farm Payroll data release influencing the FOMC decision one way or the other nor on them withdrawing all of the liquidity provided too quickly. The approach will be gradual. Of course there will be worries of the markets front running the exit and ensuing serious fall out in the bond markets but central bankers have been very resourceful at finding ways of controlling markets exuberances. It seems to me that all of this should not be a surprise as it has been already widely and openly debated. What we observing is rather more likely to be a case of the market going in summer mode to take a few Bulls out for a ride. In those moment of frenzy I like to look at some quantitative risk classifiers rather than focussing on the flurry of headlines of journalist and analysts who are paid by the line. The level of implied volatility in the equity market as express by the VIX, sometime labelled the fear Index is a good start but it does not give us the full picture. I tend to prefer to look at the volatility of the VIX itself as a measure of (un)stability of the perception of risk (I.e how volatile and unpredictable the risk itself has become). Finally the ratio of the two (VIX Volga / VIX) which I label the shock index is also a good measure as it expresses how quickly the risk has become unstable over a window of 21-day. The chart below shows these measures and also frame them within their historical distribution.
So far it does not seem that the market is behaving in a dislocated way…..I ll hang on those long equity positions for a while then…