Jun 292015
 June 29, 2015  Posted by at 7:31 am Finance Tagged with: , , , , ,

G. G. Bain At Casino, Belmar, Sunday, NJ 1910

It is with immense pleasure that I can introduce the return to The Automatic Earth of my friend and co-founder Nicole Foss. If only because I myself can now retire to a beach chair…. (not).

With the violent swings that have started and been amplified in Asia overnight, as well as in European and US futures, Nicole’s piece on volatility is quite pertinent.

Nicole Foss: A recent Business Insider chart of the day feature was particularly interesting. Called The stock market is asleep, it observed that the US market has been in a period of very low volatility:

Market technician Ryan Detrick noted that it’s been 8 weeks since we’ve seen a weekly move of at least 1% up or down in the S&P 500. That’s the longest such streak we’ve seen in 21 years.

The suggestion in the article is that the market will go on rising until the economy enters a recession, the implication being that a long period of low volatility is a sign of market health. In fact it is quite the opposite. A sleep-walking market is a reflection of complete disregard as to risk.

Markets enter such periods of complacency when there has been a long uptrend, with periods of very low volatility reflecting where the market has come from, not where it is going. Such periods are far more likely to be a sign of an impending trend reversal than of a continued uptrend.

Under normal circumstances, markets can be expected to show more variation, with regular inhalation and exhalation indicative of healthy risk perception. The loss of that pattern, indicating extreme complacency, is a leading indicator of a rude awakening. The VIX index, or volatility/fear index, is at extreme lows, indicating a historic level of complacency. It is no surprise that this coincides with a market extreme.

In short, market sentiment is a very effective contrarian indicator. When fear and volatility are low, there are typically few opportunities left and investors are openly flirting with danger they fail to perceive or acknowledge in their search for returns. Leverage balloons as riskier and riskier bets are made, along with bets on top of bets on top of bets.

Continuance of the prevailing uptrend becomes received wisdom as the combination of optimism and leverage drive the market higher in a self-fulfilling feedback loop. Bears capitulate over time, and as the last holdouts capitulate, the trend reversal become imminent. Risk typically returns with a vengeance, taking market participants by surprise.

The perception of risk shifts dramatically, from complacency to extreme risk aversion, and it can do so very quickly. In fact there already appears to be a shift underway, a mere two days after such an expression of complacency. Volatility and fear go hand in hand, and as increasing fear drives financial contraction and deleveraging, volatility goes through the roof.

The increasing and cumulative risks previously taken begin to manifest, piling on top of each other on the way down. A flood of margin calls overwhelms a mountain of IOUs, rendering them largely worthless. Excess claims to underlying real wealth are destroyed. Ironically, it is at this time that opportunity increases dramatically, for the relatively few who perceive it and are in a position to take advantage of it.

We are approaching just such a juncture at the moment. The long uptrend appears to be finally coming to an end. It is at extremes when it pays most to be a contrarian. Apart from the misinterpretation of low volatility as being good news for the stock market, another misconception is that market corrections are driven by recession.

Causation runs in the other direction. It’s not that a recession causes the markets to fall, but that a market trend change to the downside is a leading indicator of economic recession. Changes in finance, which is largely virtual, happen far more quickly than changes in the real economy.

When the trend change comes in finance, a similar direction change in the real economy can be expected to follow, with a time lag thanks to the longer time constant for change in the real economy. If the downward shift of the last couple of days does indeed mark the long-awaited trend reversal, then economic recession is sure to follow.

There is a substantial potential for the reversals in both finance and the real economy to be very large, as we have been predicting here at TAE for some time. This is yet another high risk juncture. Be careful.

Home Forums Volatility and Sleep-Walking Markets

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    G. G. Bain At Casino, Belmar, Sunday, NJ 1910 It is with immense pleasure that I can introduce the return to The Automatic Earth of my friend and co-f
    [See the full post at: Volatility and Sleep-Walking Markets]

    Formerly T-Bear

    Good to see your impressions here again. Ilargi is being overworked with the Greek hullabaloo; many hands make for light work.

    One question, just how is the driving algorithm of the Fed intended to provide liquidity to equities, keeping those markets afloat – see just how connected US and European major markets are in time, supposed to provide volatility as well given HFT algorithms are also present? What happens when these algorithms contradict one another or is that getting into black swan territory?

    Another question. Zero Hedge posted this:
    where the writer proudly asserts Keynes’ “General Theory of …” is unreadable (presumably because the writer has never attempted to read it) and proceeds to quote from Misses and Hayek, founders of the Chicago School of Economic Phrenology, Political Disinformation and Social Delusions [full title] upon which the neoliberal thought collective (h.t. to Philip Mirowski) has grown like a mushroom in old manure kept in the dark. Just how enlightening is the thesis in that article in your estimation? What purpose might it be serving or is it something to reenforce economic ignorance?


    Hi Nicole. Great to see you here again!

    With regard to your observation that less variability in the market could be a sign of lack of corrective feedback (because of complacency) and therefore destabilising, there is a biological example of this which might have the same mechanism: The human heart exhibits variation in heart beat frequency. When that variation stops, the person is at risk of a heart attack. I wonder if the heart goes out of safe parameters because of the a lack of corrective feedback?


    I know it’s a daft comparison, but I’m trying to exercise my systems thinking

    Diogenes Shrugged

    I read Ilargi for information, perspective and entertainment. I read Nicole for wisdom. For instance:

    “Changes in finance, which is largely virtual, happen far more quickly than changes in the real economy.”

    Confirming that “black swans” happen in finance first, economies second?

    I agree with everything here save one thing. I don’t agree that there is a correlation between “longest streaks without a 1% move” and major downturns. In fact, the chart seems to presage an uptrend – – the only major change in trend on the chart – – after the 1993 and 1994 “streaks,” but still I doubt that there was a correlation.

    Rather than reflecting complacency, I suspect these streaks reflect uncertainty about future liquidity. Kind of like how the appearance of complacency in “the hand slap game” masks underlying uncertainty.

    Even a blind man knows when the initial ascent of the roller coaster turns convincingly downward, affirmed by the mounting screams. It soon becomes clear to all that there is no turning back.

    I think we’re beginning to hear the screams.

    Dr. Diablo

    Thanks for all you do. You are on the ground at a historic time. I can’t imagine…

    Craig Morris

    I just made a donation in honor of Nicole’s return.

    I like the heart failure analogy. My analogy would be a marriage: if there is no volatility you’re probably pretty close to divorce.

    Also, a comment on the comments section. A post with a comment section once a day or more doesn’t allow comments to reach critical mass. People want there comments to be read and responded to and currently they lose top billing too quickly. I appreciate immensely the work Ilargi (and now Stoneleigh) have been doing to explain the goings on but I also miss the TAE comment section of TAE 1. It would be nice if we could have both.

    John Day

    @Carbon Waste Life Form and Craig Morris
    The reduction of beat-to-beat-variability in the human heart generally means that there is some underlying systemic stress pushing the heart toward a limit, rather than it comfortably idling in the middle of the range between parasympathetic relaxation, and sympathetic stress.
    Loss of short-term variability in heartbeat is a sign of cardiac stress.
    This is one of the things closely monitored on unborn infants during labor, for instance.


    Greetings! We here in western NYS are experiencing a cool monsoon season. Tough to make hay. Our family is working to establish a holistic goal for transitioning to what comes next. TAE has been a valuable resource, urging kindness and caution going forward. Please report on the status of Greek agriculture, as to what might be instructional to our situation here. Thanks.


    @John Day

    Thanks for the medical clarification. I had attributed heart beat variability to weakened feedback control of the heart which possibly led on to physiological stress rather than heart stress leading to reduced variability. I guess I got it backwards.
    It is hard to see what’s cause and what’s effect sometimes if you don’t know a system well enough. That problem maybe catches out the unwary economist, or the dogmatic one.
    Was is Mark Twain who said something like : “it isn’t what you don’t know that’ll get you, it’s what you know for sure that just ain’t so” ?


    Woah, Hoss, timing or what? VXX up 17% today! Just the Greek pony show, or something more?


    On another note, have to take note of your comment there, Diogenes. 5 Sigma “Events” generally happen unannounced 😉


    John Day – I’m guessing one reason might be too much pressure? Then there are arrhythmias:

    “Heart rhythm problems (heart arrhythmias) occur when the electrical impulses that coordinate your heartbeats don’t work properly, causing your heart to beat too fast, too slow or irregularly.”

    Knew a young person who almost died from the above. I guess there’s all sort of causes to make a heart react, just like a stock market. Too much, too little, a power outage that knocks out all of the high frequency trading machines at the same time. Lots of variables.


    Nicole – So nice to hear your voice. Great article! And you can tell it’s a great article because it gets you thinking of all sorts of analogies: the heart, marriage, friendship, space, any system. Thanks, Nicole.

    Carbon – I like your systems thinking. I enjoy doing that too.

    Craig – good marriage analogy. Bang on! If there is no airing of grievances, it’s probably a dominant/dependent relationship, too much pressure from one side, not equal. The volcano eventually blows; it just takes longer.



    How exactly was the TAE1 comments section different? It was still one per article…

    Birdshak, I’m in the middle of the city here. ‘Fraid ag will have to wait. Sorry.

    Nicole Foss

    The biological analogies are very apt. My mind works that way too…

    Nicole Foss

    Rare events (5 sigma if you like) aren’t often completely unannounced. If you are working with a meaningful model and know what leading indicators to look for, high risk junctures for particular kinds of events can be identified. It’s not an exact science, but a set of guidelines is still useful if one doesn’t want to be taken by surprise.

    Nicole Foss

    Agriculture will be suffering from liquidity crunch in the same way as other sectors of the real economy. When money is scarce and the velocity of money is low, it is difficult to access credit, difficult to service loans, difficult to purchase inputs and sell to potential consumers even for the cost of production, let alone at a profit. Where few can afford what is produced, demand is low and there is no price support. Farmers struggle to make a living. If they have overpaid with borrowed money for their land, they stand to make a huge loss in financial terms as a property bubble bursts. Of course in Greece more farmland may have been in families for generations and long since have been paid off. In other countries farmers may not be so lucky.

    Craig Morris


    Back in the day your commentary and article digest were on the same page and were not always daily (sometime two days between posts). This allowed the comment section time to ferment (so to speak). I started reading TAE in early 2009 and back then I would check the comment section multiple times a day. It was a great pleasure to read the banter between greenpa, el gallinazo and snuffy (to name a few) that arose in response to your and Nicole’s thought provoking articles. The TAE comment section was (and is) unique among the blogs I read in the thoughtfulness, tone and civility of its comments. My guess is that a small format change might encourage more of the kind of commenting we used to see.



    Very glad to see you back here – you’ve been missed.

    Great article, but I keep thinking about some of the ideas I’ve been picking up over at Martin Armstrong’s website… most notably, the idea of a “phase transition” where (US) markets should crash from their overvalued peaks but skyrocket higher due to capital fleeing everywhere else to seek safety in the US dollar and US equities.

    Just curious if TAE has considered this type of event occurring prior to the big (financial) crash we’ve been waiting for?



    Nicole said: “In short, market sentiment is a very effective contrarian indicator.”

    Perhaps, but it clearly has an extremely high “false positive” ratio. I have been reading through the archives, searching for the words of my deceased brother, and by my estimation this is about the 30th time since mid 2009 that you have stated … “The long uptrend appears to be finally coming to an end.”

    In all fairness, it does look like you did effectively call the 2009 market bottom, but you are now approximately 0-30 in your calls of “market top” since. It is a shame you did not actually test how often your “balance of probabilities” call of market top did not pan out. Will this improve your record to 1 of 31 in the last 6 years? I guess we shall see…




    but what change?


    How lovely to see you you have more of the exact same. Did you actually write that, or was it just copy and paste? And, you got a Nicole radar on somewhere? You’re more accurate with it than I am. I never have a clue when she’ll turn up. Keep me in the loop!

    Nicole Foss

    Ann, you really do not understand the model we are working with here and so make uninformed comments. Considering that you make them in the spirit of trying to discredit without trying to understand, they add no value to the discussion. I am sorry for your loss, but I really do suggest you move on. Your obsession is not healthy.

    Markets cycle at all degrees of trend simultaneously, hence there are many different scales of both tops and bottoms. It is not always possible to identify what scale of top or bottom is occurring, although there are relative indicators. Market sentiment is a major one. It is most extreme at larger tops, and historically extreme at major ones. The period of low volatility I was commenting on was the longest for 21 years. The likelihood is that it signals a notable top.

    Nicole Foss

    Variable81, that is possible, and if so might occur as a short squeeze, but I am not convinced. The flight away from risk is far more likely to be into safe havens such as US cash and short term government bonds than into equities.


    Ann – sorry to hear about your brother; I know you must be feeling a great loss.

    In defense of The Automatic Earth, I do not think ANYONE – ANYONE IN THEIR ABSOLUTE WILDEST DREAMS – could ever have imagined that the elites would throw everything but the kitchen sink at this crisis (ZIRP, QE’s flowing like water, mark to market set aside, deferring foreclosures, high frequency trading, fines for the big banks [when they should have been jailed], and on and on and on). In fact, every day there seems to be another rabbit they pull out of the hat.

    I guess we’re all still living in a kinder and fairer world (one we remember from long ago) when none of this manipulation would have occurred. Prior to the last few years, if someone had have told me that our leaders were psychopathic in character, that they would lie, cheat, steal or throw their own mothers under a bus to win, I wouldn’t have believed them. It’s been an eye-opener, the degree of evil they possess.

    They have cheated us all, even your dear brother. My heart goes out to you.


    Ann – if I remember correctly, if I have the right person, I believe that Cory sold his house prior to the crisis (or just as it was occurring), hoping to get back in when prices were lower. Is that correct? Again, if I have the right person, the last time I saw a post of his, he was fearful that he would no longer be able to get his family into the market because now prices had risen too much. I sensed a lot of pain and stress coming from him.

    If I have the right person, your brother made all of the right moves and he was correct in everything he did. Had the psychopaths I described above not been trying to save themselves from going under (as they were all insolvent), your brother would have been well ahead of the game. He acted responsibly; it is our leaders who have not. They have ruined peoples’ lives, thrown them under the bus, and turned the world upside down.

    Your brother was right, but our leaders and Wall Street were not going to allow that.



    Thanks so much for the response!

    I can appreciate your point of view, and to some degree share it. The only reason I’m thinking Mr. Armstrong might be onto something (and don’t get me wrong – I’m no fan of gambling at the equities casino!) is I think sometimes we’ve all made miscalculations on how quickly/rapidly things would deteriorate.

    Perhaps when the credit crisis starts to unfold, many “smart money” (or “big money”?) investors won’t instantly seek the safest havens for their wealth, but will be lured by the potential for short-term profits in the US equity markets as the rest of the world implodes.

    Mr. Armstrong also points out that a credit crisis in other parts of the world may wake investors up to just how “safe” government debt really is (or more corretly, isn’t), and perhaps investors will shun even short-term treasuries in favour of the equity markets out of fear of government confiscation / repayment chicanery.

    Anyways, things should be getting very interesting soon. Thanks again for your insight – should you be writing more articles in the future, perhaps you would consider doing a longer piece in greater detail on the possibility of a “phase transition” away from credit/debt into the US equity markets and why you think it is unlikely.



    Nicole said – “Ann, you really do not understand the model we are working with here and so make uninformed comments. Considering that you make them in the spirit of trying to discredit without trying to understand, they add no value to the discussion. I am sorry for your loss, but I really do suggest you move on. Your obsession is not healthy.”

    As a fellow contrarian, I understand precisely what you are working with. What I am pointing out is how unreliable these two indicators are. For example, while this spell of complacency is “the longest such streak in 21 years”, we had similar (longer) periods of complacency in 64, 65, 66, 76, etc. None of these marked a market top.

    Likewise, regarding the vix the all time low (even lower than today) was hit in Mar 1993. Mar 1993 was not a top but a precursor of a 7 year bull run when the SPX rose 265%. As such, both indicators have multiple false positives making them hardly noteworthy, or indicative of a top. Matter of fact, if they showed the opposite of what they show now, would you flip your message to say we are on the “verge” of a massive bull run? Of course not…

    At the end of the day, its a judgment call – are we really really in a period of manic optimism (meaning its time to batten down the hatches) or is this just a period of relative complacency compared to the abject fear and hysteria we saw in 2008-2012? In any event, when the March 2009 lows are smashed and we get even halfway to your predictions of the time (i.e. 90% off peak home prices, DJIA 1,000) I will congratulate you and move on. Until then, I will continue to hang around now and then until my memory of my recently deceased sibling fades into the distance.


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