in Australia and the U.S., then, so too in Canada: economic policy is presently – by historical standards – highly indeterminate. Conversely, and also as in these other countries, the volatility of the major stock market index (i.e., the TSX/S&P 60) is very low. Figure 14 plots the Canadian VIX (see “A VIX for Canada,” S&P Indices, 14 October 2010). Since 2002, this “fear gauge” has averaged 18.1. Before mid-2007, it usually remained below this long-term average. During the GFC, it spiked to its maximum (above 60 for October 2008 and to a daily maximum of 88 on 20 November 2008). Thereafter VIX fell drastically: by late-2009 it had fallen below the series average; in 2011 it spiked towards 30; and throughout 2012-2014 it fell steadily and well below its long-term average (to a near-record of 10.4 in June 2014). In mid-2015 and early-2016 it spiked; since then, however, it’s slumped well below its average (to 10.3 for December 2016 and an all-time low, 6.7, on 16 December 2016).
Some Cross-National Comparisons
Using a standardised base (i.e., January 1998=100), Figure 15 compares economic policy uncertainty in Australia, Canada and the U.S. During 1998-2007, uncertainty decreased in each country: in Australia it averaged 84, which represents a decrease of 16% from its starting point; in Canada it averaged 70, an overall decrease of 30%; and in the U.S. it averaged 92, a decrease of 8% from its starting point. Since 2008, on the other hand, uncertainty has risen – relative both to the starting point and the average for 1998-2007. In Australia it’s averaged 144; that’s 44% greater than the starting point and 72% higher than the mean during 1998-2007. In Canada it has averaged 153 – i.e., 53% greater than the starting point and 119% higher than the mean during 1998-2007. And in the U.S. it has averaged 110, i.e., 10% greater than the starting point and 19% higher than the mean during 1998-2007. Over time, then, policy uncertainty has risen in each country; it’s done so most in Canada and least in the U.S.
Also using a standardised base (i.e., December 2002=100), Figure 16 compares VIX in these three countries. During 2002-2007, volatility decreased in Canada (by an average of 33% relative to its base) and even more markedly in the U.S. (43%) but not in Australia. During the GFC, i.e., the calendar years 2008-2009, volatility zoomed – relative both to each country’s starting point and its average for 2002-2007. Since 2010, in contrast, volatility has abated by similar percentages in all three countries (i.e., by 48% in Australia, 45% in Canada and 42% in the U.S.). Compared to its GFC average, by December 2016 VIX had fallen 61% in Australia, 66% in Canada and 60% in the U.S. Finally, in December 2016 the Australian VIX equaled its level of December 2002; in Canada and the U.S., it was less than half its earlier level.
Conclusion
Can today’s combination of high policy uncertainty, low volatility and general overvaluation of stocks, bonds, real estate, etc., persist indefinitely? These things, I believe, are presently out of kilter; accordingly, it also seems to me, at some point they must realign. Specifically, either (1) uncertainty must abate appreciably or
(2) volatility must rise considerably. The aspects of policy uncertainty enumerated on pp. 5-6, it seems to me, won’t disappear suddenly or soon. VIX, on the other hand, regresses to its mean: low values today imply higher values tomorrow.
Possibility #1, which I regard as less probable, may – together with central banks’ suppression of interest rates to historic lows – continue to underpin financial assets’ very high valuations. Possibility #2, on the other hand, which I think is more likely, would (particularly if uncertainty persists or rises further, and given most assets’ very high valuations) deflate their prices. George Soros – who backed the wrong horse before and lost billions after the American presidential election – agrees. “Right now, uncertainty is at a peak,” he told Bloomberg at the World Economic Forum’s annual meeting at Davos, Switzerland, on 18 January. “So I don’t think the markets are going to do very well.” John Hussman goes further:
“If there’s any point in U.S. stock market history, next to the market peaks of 1929 and 2000, that has deserved a time-stamp of speculative euphoria,” he writes in Time-Stamp of Speculative Euphoria (13 February 2017), “… now is that moment. Perhaps there’s room for this burning wick to shorten further, but across every … method we use, the estimated downside risk of the market over-whelms its upside potential.”
Like most fears of Armageddon, Hussman’s and Robert Shiller’s (see footnote #1) are probably overblown. Yet the causes of the Global Financial Crisis remain mostly undiagnosed, its triggers continue securely in place, and authorities’ blindness and stupidity persist.13 Although Hussman makes a habit of hyperbole, Shiller doesn’t; accordingly, investors worthy of the name might regard his concerns as a plausible lower bound of the possible future course of events. This Newsletter’s conclusion plus Shiller’s concern provide two more reasons (I’ve detailed others; for an overview, click here) to maintain our extremely conservative, albeit highly unconventional, investment policy and portfolio. I therefore remain cautiously optimistic that troubled waters will ultimately provide good fishing.
Chris Leithner
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