The Economic VIX Index, Stock Behavior and Kneecapping Trump's 'Edge' On The Economy

"Gimme four more years and I swear I'll crash it for good!"

A large number of investors are fortunately familiar with the VIX or volatility index.  Basically the Vix volatility index,  is Wall Street's  "fear gauge".  It is a barometer of how unstable stocks are in responding to current crises or shocks.  For example, the VIX shot to its highest level in  3 years on Feb. 5, 2018 following the Congressional Budget Office's reaction to the passage of the Trump-GOP tax cuts.   This was on the heels of projections of $1, 083 trillion in borrowing costs for 2019, and $1,128 trillion in 2020.   The street's reaction conveyed in the VIX then was traced to the enormous borrowing costs projected for successive years.

Unlike the VIX, there is another measure called the Economic VIX Index, created by Jim Paulsen, a chief investment strategist at Leuthold Group. This index reflects the volatility  in growth.   It's important now because its history over the decades since World War II shows two things:

1) Stocks do best when economic volatility in the U.S. is at its lowest.

2) Stocks do best when economic volatility in the U.S. is at its highest.

It is clear that the stock bubble currently is feeding off of (2) which in turn is being driven by the pandemic.  In other words, the pandemic - not Trump-  is responsible for the incipient volatility which in turn is a function of the uncertainty.  Hence, the pandemic is controlling the economy.  As Frank Trentmann writes in The New Republic (September, p. 33):

"What makes this virus so damaging is its synchronized effect on activities that depend on mobility and proximity.  Fewer tourists and business travelers translate into fewer hotel and restaurant guests and fewer visitors to shops, special exhibitions, concert halls, and musicals....The virus has effectively stopped several pistons of consumer economy at once. Tourism and mobility, restaurants and retail, live entertainment and sports.  Each of these is a big sector in its own right."

Which of course makes it even more imperative the virus be brought under control, something Trump and and his retinue of ass clowns have been unwilling to do. See also e.g.

The Virus Controls The Economy - Not The Reverse: ...'

This is critical to process, given one of  the confounding aspects of current polls is the seeming edge Trump has in the handling of the economy - which for many also includes stocks (given people are looking at their 401ks as well as unemployment numbers)  Indeed, the careful observer can surmise that Trump is getting credit for what the economy WAS, pre-pandemic, not how the looming recession,  job losses, immense suffering (especially for many about to be evicted) are directly his fault for his mishandling of the response to the pandemic.  This indeed is a connection Dems need to make in their convention because clearly too many voters are not making it - else Biden would be ahead of Trump in the economy category too.

Most savvy people who actually follow events, as well as serious economists, are quite aware Trump's oafish, belated, incoherent response to the pandemic in the U.S. - including calling it a "hoax" for 2 weeks, and not having a coordinated national policy (like mandating masks ) is why the U.S. is floundering compared to so many other nations that got their acts together.  That chaos in turn is why there has not been a coherent reopening and why people (including teachers) are still not able to return to work with confidence, or go out to eat or whatever with any confidence.  In many ways Trump then has wrecked the economy,  not done anything to help it and much more to crash it.

But this is what the Dems now need to drill into people's heads.  (Many of whom are likely 'low information' voters).  This is especially as Jim Paulsen was quoted last week (WSJ, Business & Investing) as warning:

"Over the next four quarters we'll have a level of economic volatility  never before seen in the postwar period.  It will blow away the volatility of the 2007-09 recession when the Economic VIX shot up to its previous postwar peak."

His comment implies the havoc caused by Covid 19 will continue apace, and also there is little chance the virus will be under control - certainly so long as Trump is heading the government.  That means stocks will likely dive as much as rise, even as homelessness spikes and job creation sputters in the absence of a coordinated national strategy - including testing and contact tracing.

But this also means stocks are likely to continue to do well, even as the Main Street economy craters and Biden - if elected- is likely to inherit a mess ten times worse than what the credit crisis left Obama back in 2009.  Why then would stocks continue to do well in such an atmosphere of upheaval, uncertainty, and volatility?  According to Paulsen:

"This is because the economy is in an unsustainable situation and everyone is working to improve it, both government and companies.  So policy officials are scared to death and they are bringing every conceivable tool they have to get us out of the situation."


But again, we need to clarify here this is based on an expectation. But that hopeful, optimistic expectation, i.e. that "everyone is working to improve the situation" cannot happen if Trump gets a 2nd term.   This is why Michelle Obama made the remark last night: "If you  think things cannot possibly get worse, trust me they can can and they will, if we don't make a change in this election.  This is why we have to vote like our lives depend on it."

This followed her description of Trump as a person out of his depth in filling the job of president, e.g.

“Donald Trump is the wrong president for our country.  He has had more than enough time to prove that he can do the job, but he is clearly in over his head. He cannot meet this moment. He simply cannot be who we need him to be for us.” 

Hence, any positive expectation rests on Trump's defeat and it needs to be a wipe out so he can't bitch, piss and moan about mail ballots "rigging" the election. 

One last perspective on the Economic VIX:  Over seven decades it ranged from 0.2 to 3.4.  (The numbers represent the standard deviations of quarterly annualized percentage changes in U.S. nominal GDP   over the previous 3 years  divided by the average annualized quarterly growth rate over those 3 years.)  Now, Paulsen projects the Economic VIX will hit 13 in coming months.

That may well be whether Trump is defeated and a competent administration takes over, or not.

See Also:

The uneven rally that took US stocks to a record high

And:

2020 Elections | Donald Trump

People Are Taking Trump's USPS Cheating Seriously — and We Have Impeachment to Thank

by Amanda Marcotte | August 18, 2020 - 8:09am | permalink

— from Salon

And:

Covid-19 | Healthcare Policy

Trump's Death Cult Is Crippling Local Public Health Agencies, Dooming Covid-19 Fight

Maybe It's Time To Dispense With the Trope of "Market Fundamentals".

Jim Paulsen, market expert with the Leuthold Group LLC, believes the turbulence in the market isn't over by a long shot (WSJ, 'Business & Finance', 2/11). Those starting to breathe easier after last week's volatility had better buckle themselves in for more - and also reconsider the somber reality that this market is supported by "fundamentals" - an  ambiguous catchall term designed to baffle with bullshit.

Charlie Farrell – CEO of Northstar Investment Advisors LLC – put the current stock market behavior and its basis in perspective in his recent Denver Post Business column (p. 1K, Feb. 11):

“What makes bull markets so dangerous is they are not supported by fundamental growth, they are supported primarily by investor enthusiasm. When something causes this enthusiasm to wane, as it did last week, markets decline. The important point is that they eventually decline to the fundamental valuation supported by earnings”

And so, in the biggest bull market ever -  lasting from 1980 through 1999 - we saw “70 percent of the price gains from investor enthusiasm”. This set the stage for fifty percent of those gain to be given up in the ensuing bear market. That the current market is overvalued beyond its alleged fundamentals is well known which is why Farrell delivers this advice (ibid.):

“If you need funds any time in the next five years, consider keeping those funds out of the stock market . You can instead do something simple like a savings account, a CD or high quality bonds.”

That advice is not intended to help you get rich but to ensure you don't end up a relative pauper, i.e. dumpster diving after half your disposable income is left in the crapper or having to work 10- 15 more years – eating sardines and fried dandelions each day - to reach a nominal retirement.

A popular trope about the stock market peddled by assorted finance pundits- such as CBS'  favorites Melanie Hobson and Jill Schlesinger – is that you can remain in the market with confidence, 'cause the “fundamentals” are still at work. Don't believe it for a nanosecond. The only “fundamentals” at work in the current Bull (or what I call “bull shit”) market are: ridiculous leverage, and flash trading to game ordinary investors. In the right conditions both have contributed to the volatility we've seen in the past week.

In another Sunday D. Post piece, 'Robots Have Hijacked The Market', p. 1D), Steven Pearlstein informs us:

“Pay no attention to the volatility these financial wizards assure us. It's just a little technical correction. The fundamentals of our otherwise sound economy will soon reassert themselves. The truth is that the market is as irrational and divorced from fundamentals on the way up as it is on the way down. More so today as a result of the high frequency trading strategies of the Wall Street wise guys. What we've watched this week is “herd” behavior on steroids.”

Pearlstein goes on to point out that only “10 percent of trades are made by real live humans”, with 40 percent originating out of index funds or exchange traded funds (ETFs) and the remainder – 50 percent flash trades.

In such a “robot to robot” environment of “circular logic”, he argues, “fundamentals are as irrelevant as the volumes are enormous”. Worse, the multiple trades – often in the millions and lasting microseconds each take only minutes – and are done with borrowed money. This is where the leverage aspect enters.

This is as a result of the Fed's cheap money, low interest policy - which means the same flash trade investors (mainly hedge funds) are emboldened to borrow most of what they need to buy shares. According to Pearlstein:

“the low interest rates allow hedge funds to borrow $4 or $5 for every one they put at their own risk.”

He goes on:

“When prices start to fall rapidly the funds are forced to sell their positions to pay back the banks and brokerage houses, driving down the price even further. Selling begets yet more selling. Investors rushing to cover short positions, or to sell underwater options before they expire run into a similar dynamic.”

Worse, what happens in one asset class can affect all others, as I warned about in an earlier post (Feb. 6th), e.g. with asset classes moving in lockstep setting the stage for a multiplier effect.

Another aspect of flash trading that bears scrutiny concerns the tiny time advantage- called a “latency” - enjoyed by the flash traders. In this latency (see e.g. WSJ:   'CME Defect Aids Speedy Traders', Feb. 13^th, p. B1) a firm receives private confirmation of its trade before it is reported over the public feed. This applies to the CME Group Inc. for which a system defect is “yielding rich profits for ultrafast firms at the expense of ordinary investors.."

Though a CME spokeswoman claimed (ibid.)  it had “dramatically decreased the latency” she also admitted that “private confirmations were still arriving first in some cases”

This ought to be disturbing for anyone plowing money into Maul Street, especially after author Michael Lewis' book “Flash Boys”,  where he exposed the workings of flash trades and how they benefit the flash traders.

In the case of the CME Group latency defect, the typical delays to its public data feed are “measured in microseconds or millionths of a second ….much smaller than they were five years ago” But still (WSJ, ibid.): “the flaw can yield hundreds of millions of dollars in profit a year in profit to flash traders.” This according to Quantlab Financial LLC, an electronic trading firm.

The WSJ piece goes on (p. B2) to note there are various ways to exploit this latency flaw. One concerns so-called “canary orders”, which are small buy or sell orders- say for one or two contracts. In other words not large at all in scale but which nonetheless can be used to detect large trade that can move the market. (Think of the "canary in the coal mine" - when it croaks you know methane gas is around.)

How would this advantage work in practice? The WSJ piece gives this example (ibid.):

“If oil futures can be bought for $60.01 and sold for $60, a trader could place a small order to buy at $60 which would join a queue of similar buy orders at CME. If the trader gets a message saying his or her buy order was filled, that could signal that a large seller is at work and the price is about to tick down to $59.99. The trader could then quickly sell at $60 to take advantage of the expected move.”

So let's get our perspective straight: Here you are faithfully putting money into your 401(k) each month,  expecting to earn a bit for your retirement security, and just microseconds before your fund or funds tank the flash traders learn about it and get to dump the component stocks before you can get to a phone. Fair? No, but that's the only fundamental now at work in this overvalued, over leveraged market.  As WSJ columnist James Mackintosh (Business & Finance) poses the quandary for all investors ('A Historical Tie Breaks, But Trouble Still Lurks', p. B1, Feb. 10):

"The question facing investors is whether they should dismiss the 10 percent drop in the S&P from its  high hit in January, or whether it's indicative of deeper troubles ahead?"

Perhaps the more germane question to ask is: If you are an ordinary, e..g. little guy investor, do you believe the possible trouble ahead is tied to flash traders in large hedge funds betting on volatility, or simply the downstream risk of potential inflation?

My best advice? If you plan to remain in this volatile market and buy "on the dips" like the gurus advise,  just be sure you have enough disposable income to sustain deep losses over time, especially in case of a crash.  Bear in mind that a mutual fund that drops in share price from $20 to $10 has suffered a 50% loss. But for that $10 stock or fund share price to return to $20 it must gain 100%, or double. This may take not just two or three years, but more than TWENTY!