Evening Note

The Dow, the S&P and the Russell 2000 all took pretty good hits during the cash session today. The Nasdaq Comp, however, closed up 0.29%; the usual suspects — Apple, Facebook, Amazon, Microsoft and Google — doing their share of the heavy lifting.

What I find most interesting is the past two days’ action in the VIX (S&P 500 Volatility Index), closing up 6.8% today after seeing a gain of over 5% yesterday. That essentially says that there’s a notable increase in downside risk presently being priced into the options market. The Nasdaq Volatility Index, VXN, was up over 7% today.

Now, that said, as I type, equity futures are trading nicely in the green; 150 points up for the Dow and roughly .50% for both the S&P and the Nasdaq. Vix futures are trading 2.1% lower. So, not so much in the futures pit tonight.

The Fed wraps up its 2-day policy meeting tomorrow. Chairman Powell will do his best to navigate the press conference without creating an earthquake in financial markets. I suspect he and his cohorts are getting a wee bit nervous about what they’ve done to the stock market. I mean, sure, they’ve purposely lifted asset prices with record money printing, but I suspect they’re as surprised as us strategists who’ve experienced our share of bubbles and bear markets are at the extent to which they’ve succeeded amid the worst recession since the Great Depression. 

I imagine that they’re seriously talking about the monster risk in a stock market that’s sporting a valuation not seen since 1999, complete with a dotcom-esque retail investor who is literally buying bankrupt companies as if he/she has no clue how unlikely it is that common shareholders — the bottom of the food chain — will see a penny’s worth of value once those companies pay their taxes, etc., and settle with their creditors — à la shareholders of GM stock in 2009.

As for today’s emboldened bull who believes that indeed the Fed has stock prices under control and can defy economic gravity ad infinitum, well, I’m with the late great math genius Benoit Mandelbrot on this one:

“The seemingly improbable happens all the time in financial markets. A year earlier, the Dow had fallen 7.7 percent in one day. (Probability: one in 50 billion.) In July 2002, the index recorded three steep falls within seven trading days. (Probability: one in four trillion.) And on October 19, 1987, the worst day of trading in at least a century, the index fell 29.2 percent. The probability of that happening, based on the standard reckoning of financial theorists, was less than one in 1050—odds so small they have no meaning. It is a number outside the scale of nature. You could span the powers of ten from the smallest subatomic particle to the breadth of the measurable universe—and still never meet such a number.

So what’s new? Everyone knows: Financial markets are risky. But in the careful study of that concept, risk, lies knowledge of our world and hope of a quantitative control over it.

For more than a century, financiers and economists have been striving to analyze risk in capital markets, to explain it, to quantify it, and, ultimately, to profit from it. I believe that most of the theorists have been going down the wrong track. The odds of financial ruin in a free, global-market economy have been grossly underestimated.

Ah, but are we living today in a “free, global-market economy?” 

Great question!


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