Sta Hungry Stay Foolish

Stay Hungry. Stay Foolish.

A blog by Leon Oudejans

Volatility

Various stock market indices have shown historic peaks last week (eg, AEX, S&P). The NASDAQ Composite reached its all-time high already on 12 February 2021. Nevertheless, the Chicago Board Options Exchange (CBOE) Volatility Index is far from its end of March 2020 peak

Why do historically high stock (and bond) prices, amidst a pandemic, not translate in peak volatility, a.k.a in market stress?

The easiest explanation is the abundance of money supply by the ECB and the Federal Reserve to prevent an economic recession, following this global viral disease or pandemic. In that case, financial markets can no longer be trusted to find a natural equilibrium, and market prices would then be artificial. This easy explanation is also a (very) scary one.

The market prices for residential real estate (eg, houses) provide another example. I was used to a debt-to-annual income ratio of 3 to 4 (max). With an average house price of nearly 350,000 euros and an average annual income of 36,500 euros, this average Dutch ratio is now about 10x for a single person, and nearly 5x for an average double-income and no kids household.

Moreover, recent multibillion dollar/euro scandals (eg, Archegos Capital Management, Greensill Capital, Wirecard) did not cause any permanent disruption in the financial markets; just a tiny blip. That situation feels like the 1988 hit song by Yazz: the only way is up (see video).

From a risk management perspective, it’s different: the higher the altitude or elevation, the more likely a crash is near. Never forget the saying: what goes up must come down. Even financial markets are subject to gravity.

Due to their relentless money supply, the ECB and the Federal Reserve will own the next recession. The moment that they pull out of financial markets, a crash is near. That crash will be devastating as asset price inflation is everywhere (eg, art, bonds, houses, shares).

Market participants may well assume – and expect – that the ECB and the Federal Reserve are unwilling to be accountable and/or responsible (my blogs) for the next recession. That would indeed explain low volatility in financial markets.

The ECB and Federal Reserve have positioned themselves in between a rock and a hard place. Does this warrant buying financial assets? Perhaps, if you like and can afford taking risks. I prefer a worriless night of sleep. Moreover, sleepwalking towards a cliff isn’t my thing.

Elevation (2001) by U2

artists, lyrics, video, Wiki-1, Wiki-2

High, higher than the sun 

You shoot me from a gun

Note: all markings (bolditalicunderlining) by LO unless stated otherwise.

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