Over the last few months their have been no shortage of “tape bombs” that could have derailed the equity market rally at all time highs:
- U.S. Q1 GDP down -2.9%
- Commercial Airliner disappearing in thin air (was it terrorism?)
- Overzealous M&A, Facebook buys WhatsApp for $19 billion (with basically no sales)
- Failure of a Portuguese bank reminding us that Euro Debt Crisis may never end
- Mini High Valuation Equity Crash, followed by selective recovery
- High yield selloff in the spring
- War in Ukraine
- Increased tensions between Israel and Palestine
- ISIS Gains in Iraq
- Commercial Airline shot down by Ukraine rebels with Russian missiles
- Scottish independence movement
- IPO calendar heaviest since 2000
- Chinese Growth below prior targets, housing finally showing signs that top was in
- U.S. Fed finally ending QE
After 2013’s 30% gains in the S&P 500 one would think that any one of the headlines above might cause some profit taking. Despite all that, the the SPX’s year-to-date appreciation is still outpacing earnings growth, for the 2nd straight year! So maybe these headlines have simply caused the market to go more sideways than it would have otherwise. (parabolic)
On the bullish side, there are those that would point to a very favorable funding backdrop, whether for debt or equity, corporations deploying cheap cash to buy back their shares, the post-winter economic rebound in the U.S., and most importantly Europe and Japan’s intention to grab the QE baton from the U.S. Fed.
The path of least resistance has been higher as long as the Fed has been buying assets over the last 5 years. In hindsight it is obvious that little else has mattered. The SPX has been treated as a “safe haven” asset.
Very soon, investors will need to contemplate what NORMALIZED volatility should look like in risk assets. The most liquid, like the SPX, have obviously benefited from the “Fed Put” as investors have displayed little fear on most tape bombs. You could count on both hands how many days the VIX has been above the long term average of 20 in the last two years. The chart of the VIX since the heights of the financial crisis highlights one of the main by products of QE, retarding market volatility:
The decline in volatility, in large part due to the global decline in interest rates, has actually not meant lower overall equity returns, at least in the U.S. equity market. Stocks have actually performed better in the past 2 years than in the period from Sept 2010 to Sept 2012, despite lower volatility measures throughout. That’s rare. And while I have no idea when the comfortable, low volatility, one-way market ends, I am fairly certain I know how. And it ain’t gonna be pretty.
The chart below of the SPX vs the VIX since the start of 2008 will likely be the textbook desired outcome to combat financial crisis rooted in the financial markets for hundreds of years to come:
In the meantime I suspect the “tape bombs” will continue to drop with little fallout. It will likely take some sort of sentiment shift about risk taking as opposed to something geopolitical to change the mood. Let’s say we were playing Choose Your Own Adventure and we were to look out one week from now. And the headlines were:
-Alibaba IPO breaks price, causing billions of dollars in instant losses and giving investors an excuse to sell off shares in high valuation sectors not seen since early May
-Apple’s new larger phones fail to cause the “mother of all upgrade cycles” as predicted by experts, with iPhone 6 sales matching those of last year’s 5S/C, stock declines
-Scottish citizens YES vote to succeed from the United Kingdom roils currency markets and European equities see largest weekly decline since 2012
None of these scenarios are a high probability on its own. In fact, there are dozens of other paths that are possible than the one that we experience day-in-and-day-out. The issue is not even the underlying risks or the actual events. It’s that investors have been trained to join the gravy train no matter the path. When the gravy train finally makes an unexpected turn, that complacency is going to serve many risk-takers a nasty surprise.