- Stock market volatility is back.
- The years that resembled this the most were the following (going back to 1950): 1974, 1982, 1990, 1998, 2001 and 2007.
- Those were some of the ugliest years for the stock market.
I attended a client dinner the other night where there was a debate, a healthy one at that, on whether what we are seeing is a mere pause in the 109 month bull market, rivaling the longest ever recorded, or whether we are in a classic topping formation and transitioning away from said bull market.
I enjoyed the debate, learnt a great deal, and after being in the forecasting business for more than thirty years, respect the fact that there is no such thing as a sure thing.
That said, there is universal agreement that we are in a heightened state of market volatility, and it’s not just because of the Fed, trade tensions, booming fiscal deficits, and rising political uncertainty both at home and abroad. It is just a classic late-cycle development. We have seen the VIX average 18x so far this year, and what do you know, this happened in 1990, 1991, 1998, 2000, 2001, 2002, 2008 and 2009. In terms of change, as opposed to level, the annual VIX average has soared 60% this year and the only other time this happened in the past was in 2008.
I want to make this point and make it emphatically. For most of 2008, the consensus was for a soft landing until September of that year when Lehman, AIG and Merrill collapsed. Bear Stearns was viewed as a one-off. It is easy to look back and call it for what it was, but at the time, very few were calling it a recession for the first nine months of the downturn. That is simply a plain fact, just as I see pundit after pundit wax on about how great the U.S. and global economies are doing. Never mind that the data have turned sluggish almost everywhere, and the Citigroup economic surprise indices have rolled over across the entire planet.
So let’s go back to 2008, the last time the market was as volatile as it is today in terms of the first derivative of the VIX composite. Did you know that we had 32 sessions that year of gains of 2% or more?? Seriously. In fact, on October 13 of that year, the S&P 500 surged 11.6%! And on October 28, it skyrocketed 10.8%! These were the best two days ever (since the 1930s, in any event) in what was the worst year for the S&P 500 since 1937! But you should go back and read the “worst is behind us” narratives on those two days. Hope definitely triumphed over experience — much like it is today. Did you know that in the Summer of 2008, the central banks were so confident in their bullish rhetoric that the ECB actually hiked interest rates (!) and the Fed shifted to a de facto tightening bias. I kid you not.
In fact, go to the April 29-30, 2008 set of FOMC minutes and the conclusion the central bank made at that time is shocking knowing what we know now:“….the Committee felt that it was no longer appropriate for the statement to emphasize the downside risks to growth.” Seriously!
I hate to pick on anyone, and am from the school that says not to throw stones, but at the August 5, 2008 FOMC meeting one of the most famous central bankers of all time (Dallas Fed President Richard Fisher) dissented in favor of hiking rates — little more than a month before the credit system totally collapsed:
“Mr. Fisher dissented because he favored an increase in the target federal funds rate to help restrain inflation and inflation expectations, which were at risk of drifting higher. While the financial system remained fragile and economic growth was sluggish and could weaken further, he saw a greater risk to the economy from upward pressures on inflation. In his view, businesses had become more inclined to raise prices to pass on the higher costs of imported goods and higher energy costs, the latter of which were well above their levels of late 2007. Accordingly, he supported a policy tightening at this meeting.”
That day, the post-meeting press release had this in it: “Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee.”
Good call (hint of sarcasm), because for the better part of the ensuing seven years, all anyone talked about was deflation.
I wonder if I will be treating Wednesday’s set of optimistic FOMC minutes the very same way, years from now.
So back to the matter at hand. To reiterate, we had 32 days of 2% or better on the S&P 500 in 2008, which therefore begs the question as to how it is that the market retrenched 38% for the year. And that is because we endured 42 sessions in which the S&P 500 declined 2% or more. That’s why. And this is why such acute volatility tends to be more associated with the onset of bear markets as opposed to bull markets.
So far this year, we have seen seven days of 2% days or worse; and just one day, despite the euphoria on how great everything is, of a 2% gain or better. Take note that at this exact same time in 2008, we had nine sessions of down 2% or more; and we had five days of 2+%.
As Mark Twain taught us, history only has to rhyme for it to be relevant. It all sounds far too familiar to me to ignore. And while indeed the banks are in much better shape now, let’s face facts yet again — the same cannot be said for the nonbank financials whose asset base has ballooned this cycle while the traditional banks faced the regulatory tourniquet. Think of the overextended Savings & Loan industry back in the late 1980s…it doesn’t always have to include the banking sector.
So to complete the thought process here, the stock market is on an epic roller coaster ride this year. While the major averages are only down fractionally year-to-date, thanks to a ripping first four weeks to the year, the overriding story is one of acute volatility — defined by eight sessions of 2%-or-more daily moves, seven down and one up. That is not a bullish condition. Looking closely at the almanac, the years that resembled this the most were the following (going back to 1950): 1974, 1982, 1990, 1998, 2001 and 2007. If this leaves you with a warm and fuzzy feeling, please contact your physician immediately.
The main message here: tread carefully and carry an umbrella.
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