Global Markets: The Eerie Silence

Watch financial news these days, and you can't escape the feeling that the world economy is in a pretty good shape. Maybe that's why the financial markets seem anything but nervous. Here are some facts about their rare, unanimous nonchalance:

The Chicago Board Options Exchange’s VIX index, a popular measure of the stock market volatility, hit an all-time low in mid-November.

Late last year, the market strategists at Wall Street’s 12 largest firms were unanimous in their views for an up market in 2007. European investors' confidence is also flying high. And it's not just the Europeans: The historically low short-term volatility readings of "more than 150 global financial assets" suggest "complacency towards risk is a global phenomenon."

"In the credit market, the Dow Jones US CDX indices, which measure the spread investors pay for investment-grade debt, have dropped to historical lows in recent weeks" (The Financial Times). That's despite that fact that the U.S. bond market "is signaling a sharp slowdown" via the inverted yield curve.

Also in bonds, "The extra yields, (or 'spreads') that investors receive for buying risky paper such as emerging market debt and 'junk' corporate bonds are all at or near historically lows." In other words, risky paper is no longer "risky."

Since the start of 2006, the MOVE index, a bond market volatility measure (similar to the VIX index) has registered the longest period of low volatility since Merrill Lynch started the index in 1988, showing the bond market's extraordinary complacency.

In the forex markets, the European Central Bank’s "'global hazard indicator,' which measures the implied volatility of currency trading, fell to an all-time low in November.
Even the International Monetary Fund now thinks that presently,
“The challenge is not to stave off imminent risks, but to take advantage of the benign environment.”
Bottom line, investors and regulators see nothing but blue skies ahead. Where does this confidence come from? Let's try and trace its origin.
You'll probably agree that investor confidence is a product of their perception of reality. If you see the glass as half-full, you are confident about the future of your investments, too. The Elliott Wave Principle teaches that our perception of the world is a product of our collective mood. In turn, our collective mood is reflected in the stock market prices – the best indicator of social mood we know. And since global stocks have rallied for 4 straight years now, indicating rising levels of investor optimism, the current "global economic complacency" is only logical.
But here's what's interesting. If you look back at other periods of similar calm in the markets, you will notice that, for example:

The last time there was bullish unanimity among Wall Street analysts was 5 years ago, moving into 2001. If you recall, that year saw the S&P decline 13%.

The MOVE index, which measures the bond market volatility, spiked below current levels only twice before. The first occurred in December 1989, at the forefront of the S&L crisis and a significant real estate decline. The other was August 1998, during a worldwide collapse in which investors took flight from low-grade debt. Both periods were also accompanied by an inverted yield curve, which is in place now.

True, it may indeed be "different this time around." But if history is any guide, every quiet ends with a storm…

(P.S. – Last night, while the U.S. was still asleep, China's stocks dropped 9.2%. And as we write this column, the DJIA is down 140 points, and the U.S dollar is also taking a beating.)

Vadim Pokhlebkin