Is Something Big Brewing In The S&P 500?
First off, I apologize but this chart was created on July 26th. It really hasn't recognizably changed given this is a monthly chart.
I've put up a few posts over the last few months stating market volatility is going to increase. As most everything else I post on here, it's based on some type of data point(s). What really is volatility as it pertains to markets? Well, without getting into mundane topics, it's simply large moves or wild and woolly market action. Volatility could mean a blast higher, a blast lower, both, yoyo-ing or whatever. It is applicable to any market be it bonds, stocks, commodities, real estate or derivations of those markets.
Below is a chart of the S&P 500 over the last seventeen years. Overlaid on the chart is a volatility measurement. Volatility is now the lowest in a very, very long time. When volatility falls below the horizontal line on the chart, that means something big is likely brewing. How do I know that? Because even though each new generation on Wall Street believes to the contrary, markets cannot be controlled and they eventually regurgitate on low volatility.
One of my favorite quotes is "Periods of stability create instability". There are many derivations of the same quote from Hyman Minsky. But, what does it really mean? Ultimately man's hubris and arrogance always fails in any attempt to control his surroundings, nature or markets. Forces of the universe always find a way to confound those who believe they have tamed the beast. Or as is recently believed by perma-bulls, reincarnated the once dead, still dead and always and forever dead Goldilocks. Just ask the PhDs and Nobel Laureates at Long Term Capital Management whose collapse nearly took the global financial system with it. Or the market professionals who felt invincible buying portfolio insurance right before a total collapse in 1987. The list goes on and on. The road is littered with once brilliant has-beens who never learned to respect markets. Maybe that is because they are usually playing with other people's money.
While financial innovation is constructive, true genius is to respect risk, honor the beast and realize it can never be tamed. With that respect and realization comes forth strategies that take into account unexpected events and a recognition that limits should be placed on size and leverage. Especially when everyone is playing the same game. Oft this is contrary to the generally accepted thoughts of the day. Today's hedge funds and quantitative investment firms believe they have again tamed the beast with many statistical and mathematical strategies meant to "control" the markets. Here's the problem. Science is not fact. Science is simply the extent of man's knowledge at a point in time. Much of that knowledge and science is constantly being proven as inaccurate, a fallacy or incomplete. These strategies are therefore not based on fact but man's imperfect ability to apply what he may know at a point in time. And we all know that state changes over time. The current strategies involve more and more leverage (read RISK) with more and more money (read RISK) yielding lower and lower returns and producing an environment of lower and lower volatility. They too will soon perish as many before them who, for a moment in time, believed they too had tamed the beast.
In the end, it doesn't matter what causes the volatility, what really matters is the realization the shackles will be broken and the beast will be unleashed.
I've put up a few posts over the last few months stating market volatility is going to increase. As most everything else I post on here, it's based on some type of data point(s). What really is volatility as it pertains to markets? Well, without getting into mundane topics, it's simply large moves or wild and woolly market action. Volatility could mean a blast higher, a blast lower, both, yoyo-ing or whatever. It is applicable to any market be it bonds, stocks, commodities, real estate or derivations of those markets.
Below is a chart of the S&P 500 over the last seventeen years. Overlaid on the chart is a volatility measurement. Volatility is now the lowest in a very, very long time. When volatility falls below the horizontal line on the chart, that means something big is likely brewing. How do I know that? Because even though each new generation on Wall Street believes to the contrary, markets cannot be controlled and they eventually regurgitate on low volatility.
One of my favorite quotes is "Periods of stability create instability". There are many derivations of the same quote from Hyman Minsky. But, what does it really mean? Ultimately man's hubris and arrogance always fails in any attempt to control his surroundings, nature or markets. Forces of the universe always find a way to confound those who believe they have tamed the beast. Or as is recently believed by perma-bulls, reincarnated the once dead, still dead and always and forever dead Goldilocks. Just ask the PhDs and Nobel Laureates at Long Term Capital Management whose collapse nearly took the global financial system with it. Or the market professionals who felt invincible buying portfolio insurance right before a total collapse in 1987. The list goes on and on. The road is littered with once brilliant has-beens who never learned to respect markets. Maybe that is because they are usually playing with other people's money.
While financial innovation is constructive, true genius is to respect risk, honor the beast and realize it can never be tamed. With that respect and realization comes forth strategies that take into account unexpected events and a recognition that limits should be placed on size and leverage. Especially when everyone is playing the same game. Oft this is contrary to the generally accepted thoughts of the day. Today's hedge funds and quantitative investment firms believe they have again tamed the beast with many statistical and mathematical strategies meant to "control" the markets. Here's the problem. Science is not fact. Science is simply the extent of man's knowledge at a point in time. Much of that knowledge and science is constantly being proven as inaccurate, a fallacy or incomplete. These strategies are therefore not based on fact but man's imperfect ability to apply what he may know at a point in time. And we all know that state changes over time. The current strategies involve more and more leverage (read RISK) with more and more money (read RISK) yielding lower and lower returns and producing an environment of lower and lower volatility. They too will soon perish as many before them who, for a moment in time, believed they too had tamed the beast.
In the end, it doesn't matter what causes the volatility, what really matters is the realization the shackles will be broken and the beast will be unleashed.
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