The Market Shows A Lack Of Confidence In The Federal Reserve

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Includes: DIA, IVOP, QQQ, SPY, SVXY, TVIX, UVXY, VIIX, VIXY, VOO, VXDN, VXUP, VXX, XIV, XXV
by: John M. Mason

Summary

In recent days, investors have "piled into volatility ETFs" as expectations of future market volatility have grown.

A major contributor to this volatility has been the behavior of the Federal Reserve, an inconsistent behavior exhibited over the past 18 months.

This move by investors implies a lack of confidence in the leadership of the Federal Reserve and its ability to operate within the current environment.

Fed chair Janet Yellen spoke yesterday to the Economic Club of New York. The stock market responded positively to what she had to say.

But, there are other things that are taking place within the financial markets that seem to indicate that market participants have a lack of confidence in the current leadership of the Federal Reserve.

Joe Rennison writes in the Financial Times, "Investors Bet Against U.S. Share Market Rally."

The source of Mr. Rennison's claim is:

Investors are questioning the rebound in U.S. share prices and buying exchange-traded funds that offer the prospect of high returns from renewed market volatility.

Whereas:

U.S. equities have risen more than 12 percent from their low in February, with the S&P 500 turning positive for the year on Tuesday after Janet Yellen, the Federal Reserve chair, said the central bank would proceed cautiously on raising interest rates… some investors are betting that the recovery in share prices will not last and have sought leveraged exchange traded funds that track expectations of implied equity volatility via futures based on the CBOE's VIX.

Markets do not increase in volatility if market participants have confidence in what is going on. Investors, it seems, at least a large number of investors, are betting on uncertainty.

In this case, the uncertainty pertains to the future actions of the Federal Reserve leadership.

Recently, the VIX has dropped to just under 14, although during the market turmoil in January and February, it moved above 28.

What is the market facing this year?

Mr. Rennison suggests:

Analysts expect a bruising earnings season that would weigh on sentiment for equities during April. Further signs of slower global growth and a stronger dollar also pose a risk for U.S. companies reliant on foreign revenues.

What is missing from this is that the officials at the Federal Reserve provided little or no coherent leadership from the time that they put an end to the third round of quantitative easing in October 2014 up to the present. They have ignored their "forward guidance" and reversed themselves constantly.

In justification of this behavior, they have claimed that they are "data driven" or "event-driven" and consequently have to change their actions to conform to changes in… whatever.

This behavior has only added to the declining confidence in Federal Reserve leadership and has contributed to the increased volatility that has come into financial markets since the end of QE3. The leadership cannot believe that it is providing "forward guidance" to the market if it is changing its mind monthly… or over an even shorter period of time.

It is not surprising, to me, that investors are somewhat skeptical of the Fed's behavior over the past year-and-a-half.

Now, I have a great deal of sympathy for the current leadership of the Fed. We have never been through times like those that we are going through. Furthermore, with all the changes in the economy over the past decade or so, the econometric models they are using to forecast the future of economic activity are inadequate.

An interesting sideline on this is the interesting comments former Governor of the Bank of England, Mervyn King, makes in his new book "The End of Alchemy," about the adequacy of these statistical models. He seemingly totally dismisses them.

Still, one might expect that with all these difficulties that the leadership faces, that they might be a little less arrogant about their ability to provide "forward guidance." If they don't know what they are doing, why should they try and appear to the rest of the world that do know what they are doing?

In summary, I believe that the investor moves discussed by Mr. Rennison are valid and that volatility will continue through much of the rest of the year. It is just unfortunate that officials at the Federal Reserve are contributing to the volatility. It would seem like a part of the function of a central bank is to help reduce volatility.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.