Random Thoughts: Janet Yellen and the Fear Factor
Navigating the tape one stair step at a time.
Early morning markets were higher on the breaking-yet widely anticipated-news that Janet Yellen has been chosen to replace Ben Bernanke at the helm of the Fed. Yellen, who has served as vice chair since 2010, is known to have white feathers sewn in the seam of her pantsuit, symbolic of her dovish policy inclinations.
S&P futures popped six handles last night on the news, although we know that following an outsized move, the market tends to probe the prevailing direction -- in this case lower -- at least once the following session. That is the near-term script as attention again shifts to the world's wildest realist show that continues to play out in Washington.
The longer this stalemate lasts, the more the probability of a credit default will be priced into the market. It's a long shot on a deep dive but it's called a process of price discovery for a reason; and the fact that many have assigned a zero percent likelihood of this happening -- and certain political contingencies view this as acceptable -- is adding spice to an already tenuous market mix.
Has fear trumped greed, particularly given the year-end performance anxiety that is percolating in the marketplace? There's been a lot of chatter about the 57% rally in the VXO (INDEXCBOE:VXO) since September 20, which is the widely watched "fear index" that often works as a contrary indicator to the market.
Conventional wisdom dictates that this proxy trades higher as more and more hedges are put in place, increasing volatility levels and layering short exposure into the market that must ultimately be unwound.
It has proved true time and time again; spikes in the VXO are ultimately unwound as the tape trades higher. This is demonstrated in the first chart below, which tracks the VXO vs. the S&P 500 (INDEXSP:.INX) over the last 20 years.
There are two items of note in the current construct. First, the VXO is trading near 20, which is 10% below where it was this summer, when it was traded above 22. That particular move in the VXO -- an 85% increase from the May low -- coincided with a 5% move lower -- from all-time highs -- in the S&P.
Second, I'll share the 20-year chart of the VXO, where spikes in the index coincide with past crises. You will notice multiple pops toward VXO 50 in 1997, 1998, 2001, 2002, 2010 and 2011 -- and a spike above 100 during the first phase of the financial crisis in 2008.
Given liquidity is the opposite of volatility -- a large order will move a thin stock -- there is a case to be made that the massive liquidity injection by the government has quelled, or will quell, forward volatility. That may play through, although market veterans will tell you that the most dangerous four words in finance are "this time is different."
- S&P 1660 -- the 11-month uptrend, and IF the bulls are going to turn the near-term tide, this is the level that they'll do it. If the nonsense in Washington plays out into the weekend, we could see further downside, perhaps all the way to the 200-day.
BKX (INDEXCME:BKX) 62 -- the August low for the financials -- was broken yesterday, and that warrants attention; as go the piggies, so goes the poke. Goldman (NYSE:GS), JPMorgan (NYSE:JPM), Deutsche Bank (NYSE:DB), Citigroup (NYSE:C) and Morgan Stanley (NYSE:MS) remain stocks to watch in that complex.
- Sometimes the ability not to trade is as valuable as trading ability. There are a lot of funds chock full of emotion who need to do something between now and year-end, and many of them are standing in a circle shooting at each other. If you have the option of being selective and picking spots, you've got a competitive advantage that you should employ, or at least that's my take.
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Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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