- Several financial markets are showing the lowest volatility they have shown for years.
- The are several arguments floating around why this is true.
- To me,right now there is a tremendous amount of uncertainty about the future and this is being translated into the market by investors not committing one way or the other.
A fair amount of attention has been paid in the past couple of weeks to the low market volatility that has evolve in certain markets.
James Mackintosh lists some of these in a piece in the Financial Times. For example, he writes that "The 10-year yield (on Treasury bonds) has moved within a band only 23 basis points wide since January, the narrowest range for the longest time since 1978."
Furthermore, "Oil has traded between $100 and $110 for the past year-leaving it in the narrowest percentage range for the longest period since 1985."
In addition, 'The S&P 500 since February has been in the narrowest channel for the longest since February 2007, just before the subprime crisis became obvious."
And, "The dollar, too, has been heavily rangebound, at lease against other developed countries.
He cites several theories about why this lack of volatility has happened.
One suggestion is that "the combination of renewed bank lending, a decent economy, and the lack of Fed tightening are suppressing volatility."
I don't see this.
Another suggestion is that "The Fed, in particular, and central banks, in general, try too hard to keep volatility low." Connected with this comment is the concern that "low volatility is a sign of market complacency."
And, one more idea is that "volatility is absolutely definitely a 'be cautious' (signal), just like high volatility is 'get ready to buy.'" In fact, "low volatility is definitely a sign to be worried, but it's less good at market timing."
It is this last argument that I believe is the closest to where we are right now, but I would like to state things in a little bit different way.
I like to try and determine what markets are trying to tell us. Investors may not always be right, but I like to ask the question first to see if something logical can be discerned…if there is justification for the position taken by the investment community. This is a starting place.
Then, if I cannot come up with a sensible argument for the position taken by investors…then, I start looking elsewhere for what is going on.
If I do this in the current situation, I come up with the argument that the narrow range of trading in these markets is due to the uncertainty that exists at the present time. Investors just don't know which way the economy…and the financial markets are going to go.
New data being released seem to be mixed…at best. And, if the news is not bad and good at the same time…then good news will be followed in a day or two by not-so-good news…and vice-versa.
Here is an example from the employment data released yesterday. The first take on these data was that the news was very good. The economy added 288,000 jobs last month. This is the largest addition since 2012. And, economists had only estimated that number would only be 218,000.
In addition, the unemployment rate fell to 6.3 percent from 6.6 percent.
This was great!
Markets responded positively.
Then more attention was paid to the release and it became apparent that although more people had achieved jobs in March, the substantial decline in the unemployment rate was as much or more a result in the number of people leaving the job market…had stopped looking for jobs.
The labor participation rate dropped to 62.8 percent in March from 63.2 percent in February. The stunning thing to realize was that this was the lowest level for the labor participation rate since March of 1978. This earlier time was during the period that more and more women were entering the labor force, which eventually brought the labor participation rate up near 68.0 percent.
The markets dropped off.
Of course, there were other things. One of these was the situation in the Ukraine and the uncertainty connected with that. Another was the growing noise about the weak leadership being shown by the president.
But, these three situations…and more…I believe contribute to a feeling on the part of investors that they really don't know which way the economy is going to go and they are trying to stay sharp so that they can move in the appropriate direction when the time is right.
I do not believe that this low volatility range we are in is a result of market complacency. I don't think there is anything to be complacent about.
I also do not believe that the Fed…or other central banks…can achieve low volatility in the four markets mentioned above…10-year bonds, the S&P 500 index, the price of oil, and the value of the dollar. The Fed might be able to do this in the very short-term end of the money market…but lower volatility by monetary policy in these other markets…I just can't buy that.
The last argument, that the low volatility is a "sign to be cautious", I can agree with. I would argue that, in the current situation, the market could go either way.
There are some reasons why some argue that the stock market might be over valued. If one looks at such measures at Bob Shiller's CAPE index the market is over valued. Another measure, used by English economist Arthur Smithers, Tobin's "q" ratio, also is showing that the stock market is over valued. But, there is no timing connected with these items in terms of timing.
This last argument takes the position that when volatility is low, that, like these other measures, investors should be ready to sell. That this is a market near the top. But, no timing guidance is given.
And, I believe that there are still a very large number of people that believe…or hope…that the markets will rise from where they are…if the economy improves and the labor markets get better and so on and so forth. Furthermore, the economy in Europe seems to be getting stronger…along with other signs. That this low volatility is not necessarily a sign that markets are going to drop.
That is why I argue that the markets seem to be telling us that there is a huge amount of uncertainty "out there." The problem is, which way is the market going to go. In this argument of mine, the market really doesn't have any idea at all right now, where things are going!