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Bubble watch: If it ainít broke, donít VIX it!
9/20/2018 10:12:36 PM
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Investment management insights from a leading Canadian expert.

By Tyler Mordy  | Thursday, September 14, 2017


Stocks around the world are hitting new highs, the media is brimming with bubble alerts, and notable bears repeatedly cite Wall Street’s fear gauge, the CBOE Volatility Index (VIX), as a warning of broad complacency (it recently touched its its lowest level since 1993). In short, a market top seems to be the consensus. What gives?

For one, the VIX’s own history shows that it’s not reliable at predicting market peaks. Yes, the VIX hit a multi-year low in 2007, before the global financial crisis. But the VIX was hitting important lows as early as 2004, and again in 2005 and 2006. Rummaging further back in the VIX’s history shows that the indicator was incredibly low between 1993 and 1995 – a period that kicked off a spectacular boom in U.S. stocks (the S&P 500 Composite Index increased by more than 20% every year from 1995 to 1999).

Post-financial crisis mindset

The more important story is that we continue to live in a post-financial crisis period. Investors, still carrying crisis-made scar tissue from 2008, have tended to cling close to shore. Endless fears of another financial meltdown prevail. And, each time volatility erupts, capital quickly flows back to perceived safe assets (how else can you explain a sub-3% 30-year US Treasury bond?).

Crucially, history shows that these periods tend to be protracted affairs. The private sector deleverages, inflation stays low, and traditional industry is disrupted. Meanwhile, public policy fumbles around in search of an elusive “right mix” (i.e., witness the rolling alphabet soup of credit facilities – TARP, QE, LTROs and now frantic forays into fiscal stimulus). Ultimately, the key observation is that post-crisis recoveries are stretched out over long periods.

This episode has been no different. Many economic engines, like those in the EU, are just starting to rumble. Yet, we are still left with the haunting question: Are stocks in a bubble? Self-confessed “bubble historian” Jeremy Grantham of investment firm GMO, in a late 2016 report, nails the difficulty that investors face: For those “eager to see pins used on bubbles and spoiled by the prevalence of bubbles over the last 30 years, it is tempting to see them too often. Well, the U.S. market today is not a classic bubble, not even close.” Bingo JG!

False alarms

As card-carrying members of the change-anticipation field, we understand the desire to divine the big turns. To be first to spot the outlines of a looming crash can be glorious. But most warnings in the investment industry are false alarms simply because big turns are rare events. Experts overreact to small turns, mistaking a cyclical adjustment for the secular, career-enhancing kind (for full disclosure, we have erred in that fashion before).

Occupational hazards aside, Grantham is right. There is limited evidence of those essential properties of a classic bubble: broad investor euphoria; stable geopolitics; and, importantly, a massive credit expansion. None exist today, with the exception of expensive valuations in some countries around the world (notably the U.S. stock market).

Investment implications

To be sure, this has been a long cycle, particularly for the U.S.. At eight years, it ranks third out of 33 cycles recorded since 1854. But the attendant bull market has been an unloved one.

Since 2008, global investors have endured rolling geopolitical concerns, dramatic elections, viruses, Brexit, terrorist attacks, Trump’s erratic tweets, etc. … and guess what? The market has been incredibly resilient. Now try to imagine what happens if the news actually turns positive.

While we are not rabid bulls on global growth, a mild and, importantly, globally-synchronized recovery has taken hold. Yes, volatility will move higher and specific global asset booms and busts will rotate, but bubble-ologists will likely have to wait another few years for an elegant pricking of the “big one.” Or, using Grantham’s roadmap, the market is unlikely to “go bang” in the way that recent bubbles have. Instead, “mean reversion will be slow and incomplete. It is heartbreaking, for there will be no histrionics, no chance of being a real hero. Not this time.”

Tyler Mordy, CFA, is President and CIO for Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in Forstrong’s Gobal Thinking feature. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at . Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.

Notes and Disclaimers

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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