One thing you know (or learn quickly!) as a Floridian is that insurers won’t write new coverage when a storm is bearing down. The moratorium takes effect when named systems get within a certain distance of Florida, or when watches and warnings are issued by the National Hurricane Center.
Given how many insurers went broke when Hurricane Andrew devastated the region almost a quarter-century ago, it’s a logical, self-preservation step. The 1992 storm caused more than $25 billion in inflation-adjusted losses, second only to Hurricane Katrina in 2005.
In the markets, you never know when the next storm is coming. But it sure looks to me like “insurers” are writing policies all over the place – despite the very real risk of a financial hurricane approaching. And wouldn’t you know? It’s yet another distortion/side effect of very easy monetary policy.
|In the markets, you never know when the next storm is coming.|
Just get a load of this Wall Street Journal story on the collapse in the Volatility Index,. The VIX is sometimes referred to as a “fear index.” But what it really measures is the cost of using options to insure against a sharp decline in the S&P 500.
Right now, figures from the Commodity Futures Trading Commission show near-record levels of bearishness on the VIX (and consequently, bullishness on the S&P). Both historical, realized volatility, and implied future volatility, are also at near-record low levels. In fact, the S&P has only been this serene and quiescent a dozen times or so in the last half-century.
Why would volatility be so low, what with recent Brexit turmoil, uncertainty over the election, emerging market tremors, and serious questions about future Federal Reserve policy, among other issues? Because everyone and his sister is selling volatility insurance in the form of put options. They’re doing so to generate income since traditional yield-generating investments like bonds pay so little in today’s NIRP/ZIRP world.
The Journal had a great story earlier this week about how major pension funds are so hard up for cash that they’re selling hundreds of millions of dollars’ worth of put options to generate additional yield. ETF and mutual-fund providers are trying to rush funds out the door focused on the strategy, too, in order to capitalize on the demand. As Citigroup analyst Matt King said:
“Everything feels distorted and unnatural; you know the source of that is the central banks but equally there’s nothing to stop them carrying on.”
|“Everything feels distorted and unnatural …”|
None of this means the stock market has to crash today, tomorrow, or next week. But it does create the risk of future air pockets, a risk that gets bigger with every new insurance contract sold.
Or stated another way: Selling insurance is a great business … when you’re actually getting paid for the risk of doing so. It’s a great business when there aren’t any storms bearing down.
But previous periods of extremely low volatility and extremely high complacency haven’t lasted long. They’ve often been followed by significant turmoil too – turmoil that leads to big losses in short periods of time for sellers of market insurance.
What’s more, those insurance sellers are collecting very low premiums for their trouble these days. That didn’t work out very well for Florida hurricane insurers back in the day, something to keep in mind.
So what’s your take? Is this low-volatility environment going to persist? And should we continue to buy stocks aggressively as a result? Or is there a financial storm (or multiple storms) bearing down? How should (or are) you changing your investment strategy to account for that? Let me hear about it in the comment section.
Until next time,
What’s behind the Fed’s “speak loudly and carry no stick” policy – and will it ever end? Several of you took to the website to offer your answers to that question in the last 24 hours.
Reader Nels said: “If the Fed leaves interest rates low, they destroy Too Big To Fail pension funds and insurance companies. If the Fed raises interest rates, they destroy other TBTF entities – like the federal government, several state governments, and a great many large companies, which have levered up to take advantage of low rates. Whatever the Fed does, it all ends badly.”
Reader Pat L. said: “The Fed is going to continue to shoot their mouth off about raising rates. The economy is going to continue what it is doing – namely perform poorly – especially with productivity going lower. Eventually the Fed will get lower and maybe even negative rates. Then if they get to negative rates, the explosion will occur. The call to fix or eliminate the Fed will get very loud.”
Reader Cindy added: “The times we’re in scream of 1929 all over again. When everyone tells you ‘Everything is okay,’ yet their actions tell a different story, it’s time to step back – way back. It’s going to implode.”
Reader Myron said it’s not up to the Fed to fix the economy. It’ll take much sounder fiscal policy. His view: “If we get a president who is serious about shaking up Washington, cutting corporate taxes, and repatriating corporate cash overseas, then we can get back to 3+% economic growth, and higher rates. But I think the next recession could turn into a global depression before we get back to a healthier economy.”
Finally, Reader Howard offered this take on what investors should do with their money in this environment: “Most Baby Boomers have been through boom and bust cycles before. I would imagine that the careful ones are now in protection mode.
“The Fed doesn’t make or grow anything. They don’t employ large numbers in manufacturing, retail, or in any productive capacity at all. They’ve used up all their ammunition and are now firing blanks in the air. Frankly I couldn’t give a toss what Janet and her band of contradicting misfits have to say. My money is safe, accessible, secure and ready for the mess the Fed has helped create.”
Great comments all around, and I appreciate you taking the time to share them. We’re experiencing a round of eerie calm in virtually all capital markets right now … but historical experience tells us that doesn’t last forever.
With so many distortions in the markets courtesy of experimental, aggressive monetary policy, the blow up could be one for the ages. So make sure you stick with the relatively conservative, safer strategies I’ve been advocating here and in my Safe Money Report. Don’t hesitate to add any more comments you might have here on the website either.
How can big money investors make more money on negative-yielding Japanese bonds than they can on positive-yielding U.S. ones? This fascinating Bloomberg story explains this seemingly impossible situation.
It boils down to the fact dollar-denominated assets are in such strong demand overseas that funds can earn a tidy yield for lending out their dollars to needy foreign investors. That more than offsets the negative yields offered on Japanese debt. Or in plain English, it’s just another distortion caused by crazy interest-rate policies worldwide.
The U.S. government’s Committee on Foreign Investment in the U.S. (CFIUS) gave China’s purchase of a key agricultural firm the green light. CFIUS reviews proposed acquisitions for national security issues, and ruled that China National Chemical Corp. can proceed with its $43 billion purchase of the seed company Syngenta AG (SYT). The agency has previously blocked deals in other industries, particularly technology.
The Ryan Lochte fallout continues, with the Olympic swimmer losing key endorsement contracts from the likes of Speedo USA and Ralph Lauren (RL). The Japanese mattress maker Airweave and Gentle Hair Removal also deep-sixed their deals.
Did you know you can earn a positive yield on negative-yielding bonds, or is this the first time you’ve ever heard of such a seeming contradiction? What do you think about Chinese firms buying up more and more American and foreign companies? How about the reaction of Corporate America to the Lochte mess? Share your thoughts in the comment section below.
Until next time,