Economic resilience kept bond yields ticking higher, while short-term rates continued their inexorable rise. And the stunning revelations at trading powerhouse Refco gave the bearish contingent a meaty serving of capitulatory selling.
But a funny thing happened before the ghosts of Octobers past could scare market averages into the abyss: willing buyers appeared with equity bids. The VIX index, which measures expected volatility for the S&P 500 by analysing options prices, began to make lower peaks.
Recent volatility declines reinforce the trend that has increasingly taken hold since the heady trading of the previous millennium. The associated rebound in equity benchmarks has been pleasant enough, but a lack of market dislocations tends to constrain return opportunities. Without emotional disarray, few asset classes become cheap enough to offer inspiring long-term returns, and mispricings within markets rarely persist long enough to provide reliable outperformance.
Many businesses remain cautious enough to let substantial cash accumulate on their balance sheets. Constructive trends in emerging countries have accompanied lower leverage in the corporate world. Yields on emerging markets debt have declined, not only because bond investors crave income, but also because creditworthiness has improved.
Perhaps the greatest pressure on volatility, however, has arisen from the growth of hedge funds and the short sales that they often initiate. Hedge fund capital has reached $1000bn, but these huge cash allocations encompass a dizzying diversity of strategies. Meanwhile, the prominence of short selling, as evidenced by record levels of short interest on both the New York Stock Exchange and the Nasdaq, makes it difficult for downside momentum to accelerate.
Even the much-maligned US consumer doesn’t seem on the verge of collapse. Hourly earnings are still growing nicely, even as fuel prices moderate. Indeed, because October’s weather was more damp than chilly, energy supplies remain plentiful for now. From an investment point of view, however, perhaps a genuine cold snap would prove more helpful. Without some kind of shock to break volatility out of its freeze, investment returns are apt to remain lethargic, and hedge funds, institutions, and individual investors alike will struggle to find excitement.
Daniel C. Peirce, portfolio manager, global asset allocation, State Street Global Advisors.
