"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Wednesday, January 23, 2013

Complacency Index at 69 Month Low!

The following chart of the Volatility Index or the VIX as it is more commonly referred to is stunning. With today's further decline, the index has now reached levels last seen in APRIL 2007!

The VIX is a measurement of sentiment. It tends to rise and spike sharply during periods of fear or unease and decline during periods of complacency.

What we are basically seeing with today's move is investor complacency is at EXACTLY the same level SIX MONTHS BEFORE THE BOTTOM FELL OUT OF THE US EQUITY MARKETS in late 2007. I remind you that at that time, hardly a bear could be found anywhere with the exception of a few sharp traders/investors, managers who were warning of extreme overvaluations.

What is even more interesting (or frightening) is that the S&P 500 was sitting at the EXACT SAME LEVEL back in that month of April 2007 as it is this month, January 2013! Take a look and see.

Want some more mind-numbing news? The S&P 500 is  NOW LESS THAN 100 points off its all time high and 85 points off its peak level during what everyone now agrees was a MASSIVE BUBBLE in equities in the year 2000.

I must say that based on the current economic conditions, or even expected economic conditions some 6 months out, I find it hard to believe that the current level of the US equity market are rational. That they are sitting at these levels is a testimony to the ability of the US Federal Reserve, the ECB, the BOE and the BOJ to stuff massive and gargantuan amounts of liquidity into the system in order to stave off deflation. Oh yes, they have managed to stave off deflation pressures alright, at least for the time being. What they have done is to create another massive bubble in the equity markets once again. I cannot think of a better poster child to demonstrate the degree to which paper assets can be inflated by meddling Central Bankers than the US equity markets.

With bullish sentiment once again at extreme levels, not many bears around, with an economy that continues to crawl along in an "L" shaped recovery, and with no end in sight to the massive US federal budget deficits and overall federal debt, I personally believe that the US equity markets are now a huge accident waiting to happen.

Maybe I will be proven wrong for another few months as the economy/market run on these drugs in its system, but I will not be the least bit surprised to see a significant fall in stocks when it does occur. Methinks we are all going to have ringside seats to the greatest experiment in monetary history determining whether or not endless creation of nearly unlimited sums of paper currency can usher in an era of lasting prosperity and effectively do away with any fallout whatsoever from the accumulating of massive indebtedness.

One last thing - by the end of the current administration's term, the projected US federal deficit is expected to be in the vicinity of $20 TRILLION. Chew on that for a while and you will see why this market scares the hell out of me, especially with the vast majority of investors utterly complacent with hardly a care in the world.

I hope that I, along with you my readers all live long enough to see how monetary historians are going to record this. I suspect they will marvel at the blind folly of so many. It is almost as if an entire generation of investors have lost their collective minds.

REmember, as traders, we cannot fight the tape and expect to make money but that does not mean that we cannot marvel at the rank ignorance of our era.


  1. Dan,
    there is still no "nearly unlimited sums of paper currency" on the FED balance as YET... look at Japan - their debt is already twice bigger than GDP, but still BOJ is going to print again :)

    Sometime ago I read an interesting post by Mick Phoenix about Gauti Eggertson' paper from FRBNY on monetary ways to fight the deflation:


    The basic idea of the paper is to create money and buy assets to avoid the devaluation of the financial assets, including stocks. According to Eggertsson' (or FRBNY?) model, the amount of money creation may reach up to 400%(!) of the GDP... but it can be reduced "just" to 70% by the use of non-traditional monetary tools (buying private assets such as stocks, commercial bonds and foreign exchange). And this is exactly what FED is doing for the last four years... and, according to Eggertsson, it still can print and buy much more - if needed :)


    (p.286, JMCBpaper.pdf)
    "Cutting taxes and dropping money from helicopters are only two examples. The government can also increase debt by printing money (or issuing nominal bonds) and buying private assets, such as stocks, or foreign exchange. In a Markov equilibrium, these operations increase prices and output because they change the inflation incentive of the government by increasing government debt (money + bonds). Hence, when the short-term nominal interest rate is zero, open market operations in real assets and/or foreign exchange increase prices through the same mechanism as deficit spending in a Markov equilibrium.
    (p.318, JMCBpaper.pdf)
    An advantage of buying private assets, as opposed to cutting taxes, is that it does not worsen the net fiscal position of the government. It only changes the inflation incentive of the government…

    (p.20, wp0364.pdf)
    …government always eliminates any outstanding debt when the nominal rate is positive. The logic behind is simple: nominal debt creates inflation expectations
    To increase inflation expectations the government buys real assets in period 0 by printing money (or bonds)… In period 1 the government reverses this transaction by selling the bulk of real assets. The nominal debt issued in period 0 effectively commits it to higher inflation in period 1"

    1. Russian_Bear- thanks for the statistics...Yep - it will keep working until one day when it doesn't. Who knows when that will be - still - the stock market has become another bubble. The bond bubble has not finished popping yet but it will also.

      Just do not know the timing on either event.

    2. bubble has not finished popping yet but it will
      Agree :)
      The common problem with those mathematical models is that the parameters are often adjusted to fit the past, and not the future... :)
      Not to mention that the model itself is usually not fully validated (or even verified :), particularly because too little data exist about a macroeconomic scale effect from adjusting those parameters

      And thank you for regular posting, it's quite valuable (especially about the intraday market :)

  2. I guess that as long as QE continues, the direction of stocks will go on and upward. Too bad the mining stocks were not invited to the party.

  3. Thanks for the information Dan. Spoof- Markets no longer trade in market terms rather government speak terms. The so called debt problem was magically eliminated today by the House of Representatives. No problem. Just stop keeping track. Heck we have not had a budget for the Federal Government in a full administration, why worry about a debt ceiling if you don't have a budget. All is well, it is just a number Dan. Heck, I think Obummer, Bernanke, Lew, and few Harvard, Yale and Princetonites will go on vacation and get their heads together for some brainstorming ideas on how to solve the worlds problems. Wait, Davos, Jamie and the boys are already on it. Stop the worry about how we manipulate everthing. It is ok, you know, we americans have to learn how to be nice and share, well at least anyone who is not a higher up banker or government worker. We will let you know after we send all your jobs overseas through constant higher taxes and regulations. Heck all these government jobs are great. Tons of benefits, life long earnings, but your voting card better be Democratic. Don't worry about your private 401K's, IRA's and accumulated private business and property wealth. We will game the markets until you have nothing. Put it all in, JPM and the large banks will manage your money justfine. Dan you worry me with all his Market talk.

    Help us Jesus. Dan thanks for shining a bright light. I hope you know I am being very sarcastic here.

  4. "One last thing - by the end of the current administration's term, the projected US federal deficit is expected to be in the vicinity of $20 TRILLION."

    Dan, did you really mean to say federal 'deficit', or federal debt at $20T?

    From 'deficit' I understand yearly deficits. Did you mean total deficit for four years of current Obama term?

    1. Satan's_Whiskers;

      Thanks for pointing out my error on that. I did mean to write "federal debt". The federal deficits are expected to total $1 trillion for each of the next four years bringing the total from its current $16 trillion to over $20 trillion.

      What is worse, is that we have not even begun to deal with the coming entitlements!

      by the way, I did not know that satan had whiskers! :o)

    2. Lol, there is a drink by that name. I didn't want to use my real name for blogger so I selected this one at random.

  5. VIX stayed at these levels or lower for a good 3 years from 1993-95, in addition to 2 years in 05-06.

    Since it is reaching these levels just recently, this suggests the current bull market still has room to run.

    1. Unknown;

      Yes, I think it was Galbraith who might have said that the market can remain irrational far longer than your trading account can remain solvent! that is why we cannot fight the tape.

      Still, the level of complacency due to blind faith in the power of Central Banks still astonishes me!

    2. My own reading of the markets and certain economic data I follow suggest that central banks have had only marginal impact on the rally.

      I'm also reading a correction due sometime in the next 2-6 months, possibly. Depth of correction unknown at this point.

    3. Unknown;

      I would have to disagree with your assessment concerning the impact of the Central Banks. the entirety of the stock market rally since its bottom in 2008 has been entirely due to Central Bank stimulus measures. The exact bottom coincided with the first round of QE and since that time, every single leg higher has been predicated on additional QE. Throw in ECB bond buying mechanism and BOJ induced Nikkei and I think you will be hard pressed to make your case that the CB's had little to do with the global equity rallies.

      I could provide charts to prove the point but have already done so on more than one occasion comparing the price action of the S&P 500 with ever single announcement of some sort of forthcoming CB stimulus activity.
      I do think your timetable for a correction is on target. I am leaning more towards a longer time frame, something like 5-6 months out at this point in time as I suspect the liquidty binge will mask the underlying structural issues for a while longer yet.

    4. I will agree QE1 had an effect on the markets. QE2 less so, OT was pretty much useless, and the current QE's are having little effect at all. Markets do pay attention to other things besides central bank actions, after all. I think you're giving central banks more credit than they deserve, at least of late.

  6. I believe the MM's have fixed the vix...I men't to Jessie a while back and he didn't think it could be done..I think they can in a similar manner as silver and the libor....innovation of varying instruments along with computers might make it possible....it was acting odd back in Nov. and December..and I don't watch it much...not a conspiracy kind of guy...but it would be a great way to control a steady move north in they indexes...

  7. Dan, thanks for the history lesson.

    I just wish the traders would learn something from history, as you know, they are doomed to repeat it, as it seems they are.

    I just hope my family can survive the blind folly of so many investors. As you stated; It is almost as if an entire generation of investors have lost their collective minds.

    Thank you for sharing you insight and concern about the future that does not seem very bright at all.

  8. Another glorious day for Bernanke and the rest of the Central Planners.

    Consumer stocks, transports, TBTF bank stocks all going vertical while the CRB Index grinds lower, led by horrific selling once again in gold.

    Nobody in history would have forecasted this miracle Bernanke was able to pull off, only 4 years after the system nearly imploded.

  9. The problem remains: If you think QE is going to bring on massive inflation, where do you park your wealth to protect it? Cash is no good. Bonds have pitiful yields and little upside potential. Precious metals are good, but are you really going to put 100% of your wealth there? I think this is the thinking that continues to keep people in the stock market. All of the options are bad, but the stock market is better than some of the alternatives.


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