Saturday, February 2, 2013

Be Very Afraid When Fear Disappears From Markets

These days, many indicators suggest we are in an extremely low-risk market environment. The Chicago Board Options Exchange Volatility Index, or VIX, sometimes known as the fear index, has reached a five-year low. European sovereign-bond yields, long a source of anxiety, have eased since their uncomfortable march higher in 2011, and the euro has risen 13 percent from its 2010 low.

Options on currencies also suggest little fear in that market. In the U.S., the Standard & Poor’s 500 Index (SPX) rose 13 percent last year and the average forecast among Wall Street analysts is for a 9.4 percent gain this year, supported by growing profits and investor willingness to pay more for each dollar of earnings. In Europe, bank balance sheets are still fragile, but the rally in share prices inspired by European Central Bank President Mario Draghi’s “whatever it takes” pledge last summer left financial companies in far better shape to weather turmoil.

To be sure, meaningful progress has been made in escaping the abyss of systemic risk that enveloped the U.S. in 2008 and Europe in 2011. But policy makers should avoid the trap of reading too much into this stable environment. (more)

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