Tags: volatility | investor | stocks | fed

Will Low Volatility Remain the New Normal?

Will Low Volatility Remain the New Normal?
(Dollar Photo Club)

By    |   Friday, 17 June 2016 07:30 AM EDT

Sometimes, doing nothing is the best thing you can do as an investor. The same is true of policymakers. Responding to rapid, short-term changes with new long-term policies could become a disaster.

The Federal Reserve didn’t change interest rates this month, despite weeks of hinting at a quarter point rise. With the election on the horizon, chances are there may be one more quarter point hike, if any.

But in this case, doing nothing is bad. Why? Because this situation of low interest rates is great for borrowers but bad for savers. And it’s untenable. No human system is stable forever. Change can come gradually, or suddenly.

By refusing to make more gradual changes, the Fed is making it more likely that there will be a sudden change in the system, which will no doubt come as a shock to many.

Yet this situation is also what Mohamed El-Erian, head of Pimco, the world’s leading fixed-income traders, called “the new normal” following the financial crisis when interest rates were first lowered to near zero globally.

This new normal has been, in simple terms, the expectation of lower returns. Rather than the go-go days of the tech or housing bubbles, investors would remain cautious, staying invested in assets that meant lower implied returns over time.

That new normal wasn’t just driven by investor behavior, however. It was driven primarily by central banks, which lowered interest rates to keep the economy from stalling, but have then kept those rates low far longer than in previous economic cycles.

The biggest way to see this trend isn’t from the returns on stocks or bonds. Rather, it’s how market volatility has dropped significantly thanks to the supportive actions of central banks.

That’s because volatility, otherwise known as the “fear gauge” is something that traders keep a close eye on. After all, this measure of market activity surged during the financial crisis to an unheard-of level of 70 compared to an historic average in the 17-20 range.

So it’s important to traders. Personally, I’m not quite obsessed with volatility. At least not yet. But it’s close due to the importance traders place on it. But I think that importance is overstated. That’s because it makes most people think of that worst case scenario—another crisis of confidence in our financial system that indicates the world is falling apart.

Markets rhyme, but they don’t repeat. The next big crisis won’t look like our financial crisis. Expecting volatility to perform the same way doesn’t make sense. The tech bubble swept in day traders and white collar workers. But the housing bubble swept in an army of home flippers, real estate agents, blue collar construction workers, and new homeowners who didn’t have a job to make payments. The next rally will have different characteristics.

And right now, markets are priced to perfection, so such a new crisis could emerge anytime. We’ve become used to nice, clean rallies. But back in the latter half of the 1990’s, we’d have volatile rallies. Tech stocks would get slammed in the summer with 20 to 30 percent declines, only to rally strongly and post gains for the year.

Remember, volatility isn’t always bad. And as long as we do have sizeable pullbacks from time to time, weaker traders will lose money and the stronger will survive. These pullbacks are necessary to keep people from even thinking about getting overextended in the first place. But now we’ve had a long period of historically-low volatility. A 20 or 30 percent drop in stocks, which can and will happen every decade or so, seems far out of place.

That’s because the idea has taken root that central banks hold the solution with low (or even negative) interest rates and the implicit backing of the market in times of trouble. I’m not sure that’ll be the case either in the event of a market crisis. But as long as the perception of that safety is there, markets likely won’t fall more than 10 percent from their peak, as has happened three times now since late 2014.

Volatility won’t remain low forever. And it will affect different asset classes at different times. Volatility soared in the energy markets in late 2014 when the crash came to oil prices. It continued through February of this year. Oil prices made some daily moves of 6-8 percent, far outside their historical norms.

There’s no complete way to protect against bigger market swings. Just remember that some of those swings benefit, and that market fears tend to play out over 18-24 month periods.

Bear markets can last longer before they get back to their old highs, but that’s the worst of the worst.

With valuations above average in stocks and bond yields at historic lows (especially the negative yielding issues), the best defense right now is in cash, particularly the US dollar. That currency isn’t perfect, but it’s the best in a bad neighborhood. Gold is likely a fine store of wealth if you buy at today’s prices, but it won’t truly shine as a defensive play unless the next crisis that unfolds is monetary in nature.

In either event, today’s new normal is showing signs of cracking. And if the Fed’s refusal to keep hiking interest rates even modestly is any indication, the change will be sudden, not gradual.

What’s an investor to do now? There’s nothing wrong with raising extra cash now. That’ll now only allow you to avoid future losses, but will give you the power to buy when the inevitable panic does arrive.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and is managing editor of Financial Intelligence Report. To read more of his work, GO HERE NOW.

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Sometimes, doing nothing is the best thing you can do as an investor. The same is true of policymakers. Responding to rapid, short-term changes with new long-term policies could become a disaster.
volatility, investor, stocks, fed
Friday, 17 June 2016 07:30 AM
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