Repressed Fear

This nice chart comes to us from the  Leuthold Group via Bloomberg.   It illustrates that market fear or risk aversion is at its lowest levels since the 1980’s!  Yikes!

The Leuthold Group constructs their Risk Aversion Index (RAI) with a combination of market based indicators,  including credit and swap spreads, implied vol, currency moves, and commodity prices.   No doubt quantitative easing is  repressing market fear.

They also note that periods of low risk aversion tend to run longer than streaks of elevated risk aversion.   How long this time?   We don’t know but we’re going to think long and hard over the holiday about the potential macro swans in 2013.

Here’s are eight starting thoughts we will contemplating and researching:

1)  Japan pushes too hard with fiscal and monetary easing and tips over into a debt and currency crisis;  2)  markets begin to fret over France and Italy;  3)  the U.K. starts to have trouble and doubts increase over its debt sustainability;  4)  inflation begins to creep up calling into question the sustainability of global quantitative easing due to the rise of stagflation;  5) increased political instability caused by stubbornly high unemployment;  6)  the U.S. can’t get it together politically to implement the necessary structural economic and fiscal reforms;  7)  China’s financial and credit problems surface and create panic in the local financial markets;   and 8)  geopolitical tensions in Asia get hot.

How will these affect our trading?  We’ll go with the trend, keep them on our radar and try to find cheap avenues to express or hedge the swan events.

Dec20_RiskAversion(click here if chart is not observable)

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One Response to Repressed Fear

  1. Roger Fox says:

    “No doubt quantitative easing is repressing market fear.” (GMM)

    Are you sure? Perhaps CB activity is papering-over the consequences of fear, more so than eliminating the ‘fear itself’. Investors’ record-appetite for bonds isn’t a sign of the absence of fear, is it? Matter of fact – that folks still buy/hold them when they yield close to nothing is a confirmation of fear, isn’t it?

    All of those horrors you list but one are entirely matters of choice, essentially political in nature. But one of them is pure math. Isn’t the blackest swan of all item 4 – inflation begins to creep up? That would be expected to cause an immediate rise in all but the shortest-term rates, and balance sheet impacts on holders of long-dated paper of all types – a big-time (panicky) bond sell-off/rate-spike is only to be expected . Bondholders think they are in a ‘safe’ position – emergent inflation puts the lie to that. Rates rising in pursuit of inflation runs the risk of bringing the whole house down, right? What swan is darker than that – or more likely?

    I’ve never in my life invested in gold or other ‘alternative’-type things (or advocated doing so); however ….

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