Tuesday, October 28, 2008

Volatility

Here is a graph of the S&P 500 index vs the CBOE Volatility Index (VIX) since 1995:


The VIX is a tool traders use to try and gauge the uncertainty of the price of S&P 500 stocks 30 days from now. The higher the VIX, the less sure traders are that their guesses about future prices will come true. As you can see, the recent spike dwarfs any other uncertain time in the past, including the Dot Com Crash, September 11, 2001, and Gulf War II.

I believe that the lack of a clear vision from the Federal Reserve and what appear to be arbitrary policy decisions by the Treasury are at least partially to blame for this volatility. Every single bet being made right now could be altered by the decisions of government. Until January 20, 2009, any wager made at the gambling tables of Wall Street could be taken by the house.

**Update**

Here's a list of the 15 best and worst DOW days of all time, courtesy of Macro Man. Strange bedfellows indeed:

12 comments :

Anonymous said...

"I believe that the lack of a clear vision from the Federal Reserve and what appear to be arbitrary policy decisions by the Treasury are at least partially to blame for this volatility."

Agreed - It should be noted that this all started when they decided not to bail out Lehman. I mean you bail out Bear Stearns, but not Lehman? Either bail them both out, or bail neither of them out. The picking and choosing was the epitome of arbitrary & capricious decisionmaking.

Max said...

Interestingly, this graph also shows the inherent (and possibly irrational) bullish bias of traders. Remember, the VIX tries to measure uncertainty in future pricing, not just the chance prices could fall. If traders were being honest with themselves, the would be surprised to the upside just as often as the downside. Yet the VIX spikes only when prices fall. A key indicator would be when the VIX shows increases on bull runs vs bear runs.

Patient Renter said...

Agreed - It should be noted that this all started when they decided not to bail out Lehman.

You seem to imply knowing that things would have been better had Lehman been bailed out. We don't know.

The fact is too many companies have too much debt and need to fail. Rescuing them does not benefit the economy, it harms it. From Frank Shostak:

"The government package is not going to rescue the economy, but it will rescue activities that the economy cannot afford and that consumers do not want. It will sustain waste and promote inefficiency, draining resources from growth and efficiency."

As they say, you can't get something for nothing. The idea that you can choose to use economic resources to subsidize activities that the market has deemed unworthy and somehow come out ahead is ridiculous.

Anonymous said...

Believe the volitility comes from the lack of respect for the PHeD. I'm certainly no longer impressed.

Even though prior Fed chairs made some of the same mistakes, they had a belief system and it instilled confidence.

Treasury chair showing some leadership, not Ben.

Sippn

Anonymous said...

"Patient Renter said...

You seem to imply knowing that things would have been better had Lehman been bailed out. We don't know."

Thats not really what I am saying. I said, either bail them all out, or bail none of them out - just dont change the rules mid stream.

If the govt wanted to turn this into a socalist regime and bail everyone out, so be it. If the govt wanted to stick to the pillars of capitalism, and bail none of them out so be it. Thats not the issue...

The issue is one of certainty. Certainty of a bad thing is better (in terms of volatility) than uncertainty of a good or bad thing. If the govt was going to turn this country into a socalist state, it could telegraph that to the markets, and the markets could price that in ahead of time.

Now, once the govt decided to bail out bear, the markets priced in that All big companies are too big to fail. Problem was, once the govt decided to change course and NOT bail out lehman, the market didnt believe them. Every time, right before another bailout, the govt would say, "im not gonna bail you out" and then do it anyway. The market got to where it relied on this behavior - "govts fulla shit, they'll bail em out" - we had certainty....

The one time they changed course and said "im not gonna bail them out" and then DIDNT do it, the market said "OH SHIT, THEIR NOT KIDDING THIS TIME, THEIR NOT GONNA BAIL EM OUT"!!!!

The rest is history...

Patient Renter said...
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Patient Renter said...
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Patient Renter said...

Thats not really what I am saying. I said, either bail them all out, or bail none of them out - just dont change the rules mid stream...The issue is one of certainty

Yea, I get what you are saying. Without consistency in economic policies, investors suffer greater risk and the market is more volatile.

But consider too, fairness. A market economy that lacks fairness and discipline, where as you point out winners and losers are picked by the coersive power of the government, is an economy that disincentivizes participation, work ethic, innovation, etc. It's the same problem as exists with classical socialism, why work hard when some super power controls your destiny? So greater than creating an environment of uncertainty for investors, bailouts create an environment that disincentivizes productibity in the greater economy, which in theory, is to the detriment of us all, including investors.

Therefore the best approach that satifies the need for consistency and fairness is to not bail anyone out.

Darth Toll said...

It's interesting to note, although not a surprise to me, that the BEST days of all time came during extreme bear markets and only during these times. Let this be a lesson to anyone that thinks that a 900 point upward move on the DOW is a good thing. All it does is confirm that we are in a huge bear market and offers a relief rally to allow a continued slide.

It seems like every one of the CNBS idiots wants to make a lot of hay about a huge up move - that this is somehow the start of a new bull market or the bottom is in. ROFL! Not by a long shot:

http://market-ticker.org/archives/634-Beware-Bottom-Callers.html

It turns out bull markets are boring and and you don't get panic short covering like that. Also, bottoms aren't put in from "V" formations and double-tops. Just doesn't work like that.

Max said...

It turns out bull markets are boring and and you don't get panic short covering like that. Also, bottoms aren't put in from "V" formations and double-tops. Just doesn't work like that.

Speaks to the human condition more than anything else. Irrational behavior begins with complacency. Boiling the frog slowly, so to speak. Right now, the pot is roiling, and anybody who jumps in will be cooked alive.

Darth Toll said...

Max, Now that Wells has a lifeline to the TARP, what is stopping them from being the first to dump their massive shadow inventory? He who panics first panics best, after all, and now a dump won't destroy them.

http://calculatedrisk.blogspot.com/2008/10/wells-fargo-issues-shares-to-tarp-for.html

BTW, if you google the term "shadow inventory", your site comes up first on the list!

Max said...

Max, Now that Wells has a lifeline to the TARP, what is stopping them from being the first to dump their massive shadow inventory? He who panics first panics best, after all, and now a dump won't destroy them.

The dump has already started. Have you seen the Countrywide foreclosure list lately? Parabolic growth.