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Generational Dynamics Web Log for 1-Apr-2011
1-Apr-11 News -- Portugal's and Ireland's bond yields soar, but VIX remains low

Web Log - April, 2011

1-Apr-11 News -- Portugal's and Ireland's bond yields soar, but VIX remains low

Oblivious investors continue to push stock prices up

Portugal's and Ireland's bond yields soar, but VIX remains low

The euro crisis increased on Thursday, as yields (interest rates) demanded by investors to lend money to Portugal or Ireland through 10-year bond purchases soared to new highs. Higher yields on government bonds indicate that investors believe that the country is more likely to default.

Ireland, Portugal, 10-year bonds, 3/31/2011

Ireland, Portugal, 10-year bonds, 3/31/2011

Portugal announced that its budget deficit for the year 2010 was considerably higher than officials had previously predicted, or committed to, according to the Telegraph.

This was just the latest blow to Portugal's government, just one week after Portugal's Prime Minister Jose Socrates was forced to resign, because the parliament rejected his austerity plan. The parliament was dissolved on Thursday, and new elections are scheduled for June 5. The news pushed Portugal's 10-year bond yields to an astronomical 8.6%. (By contrast, yields on US 10-year Treasuries are around 3.4%.)

Ireland's government announced that it must spend $34 billion more to bail out its banks, according to the Daily Mail. This lifts the cost of staving off a financial collapse to almost $100 billion. Ireland's 10-year bond yield exceeded 10% for the first time, even though Ireland was already bailed out last year.

However, none of this disastrous news had any noticeable effect on bubbleheaded, oblivious Wall Street investors, where stock prices rose another 0.6%.

Several commentators have been pointing out that the Volatility Index, or VIX, has been extremely low recently. The VIX indicates how nervous traders are that stock prices might fall. A high VIX means that traders are using hedge funds to hedge their stock purchases, while a low VIX means that traders feel safe just owning stock, without any hedging.

The following graph from FT Alphaville shows the VIX since early 2008:

VIX - 2008 - Present

VIX - 2008 - Present

The VIX spiked on three occasions since then:

The financial crisis following the Lehman Bros. bank collapse.
The euro crisis, leading to the EU bailout of Greece.
The beginning of the Mideast crisis.

The VIX spike was lower each time, indicating that traders are increasingly oblivious to risk.

I remember back in 2006-7 when I kept writing about airheaded investors pushing the stock market up to bubble heights. When the economic news was good, the stock market went up because the news was good. When the economic news was bad, it meant that the Fed would have to lower interest rates again, so it was really good news, and the stock market would go up again.

Today, the situation is much worse because investors are just totally oblivious to what's going on. Each time a crisis is averted by some government action that simply postpones (and worsens) the problems, more investors conclude that there'll never be a problem that can't be postponed, and that the market will go up forever.

A strategy note by Macro Economic Advisors (PDF) says that "we think the market is substantially mispricing the degree of uncertainty that has materialized over the recent time period. We believe risk appetite is vulnerable."

The note provides "The Octagon of Uncertainty" to portray the various risks:

The Octagon of Uncertainty

The Octagon of Uncertainty

The risks include:

The European debt crisis in Portugal, Ireland, Greece and Spain.
Increasing unrest and violence in the Mideast
The increasing price of oil (related to the Mideast unrest).
Uncertainty in corporate earnings, resulting from spiking commodity prices. Also, the continuing collapse of the housing market.
The end of quantitative easing, along with the precarious US debt situation.

It's truly incredible to see this going on.

From the point of view of Generational Dynamics, the real financial crisis has not yet occurred. I've been truly impressed by the ability of governments and central banks to always find a way to avoid dealing with any problem with some band-aid that works for a few months.

But any one of the items in the Octagon of Uncertainty could trigger a panic that would shock the financial system and cause a collapse within a few hours -- too fast for a new band-aid to be applied. It might happen tomorrow, or next week, or next month, or maybe next year, but it's absolutely certain to happen.

(Comments: For reader comments, questions and discussion, see the 1-Apr-11 News -- Portugal's and Ireland's bond yields soar, but VIX remains low thread of the Generational Dynamics forum. Comments may be posted anonymously.) (1-Apr-2011) Permanent Link
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Generational Dynamics Web Log for 1-Apr-2011 1-Apr-11 News -- Portugal's and Ireland's bond yields soar, but VIX remains low

Portugal's and Ireland's bond yields soar, but VIX remains low

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Generational Dynamics Web Log for 1-Apr-2011
1-Apr-11 News -- Portugal's and Ireland's bond yields soar, but VIX remains low