The Only Thing To Fear Is Mild Anxiety Itself

Wall Street is worried. But does it really have a reason to be?

The CBOE Volatility Index (VIX)—the so-called “fear gauge”—has had some rough sledding lately. After 15 months circling in a holding pattern in the 10-to-15 range, the line rocketed straight up to 37. Since then, it settled into another range between 15 and 25.

Some perspective.  The only time the VIX was uncomfortably stuck above 30 for more than three straight months was during the Great Recession. Even then, it wasn’t until Lehman Brothers’ September 2008 meltdown that the VIX reached that level—kind of a lagging indicator. The VIX would double, reaching the 60s a few weeks later, and on a few days it reached a stratospheric intraday high of almost 90.  And if you are curious, when the S&P 500 bottomed on March 9, 2009, the VIX closed at 49.

The VIX’s spike up to 37 last month was just that, a spike … a furious, although temporary event. It also occurred annually, like clockwork, in 2009, 2010 and 2011, then quickly became last week’s news as the slow, steady recovery progressed. Same thing happened in August 1998 in the middle of the dotcom boom. It actually dropped into the teens during the mini-recession that followed the tech bubble bursting.

Where is the VIX right now? It’s near the historical norm—so you see that we’re actually in pretty familiar territory.

Our agitation today is about one-third what it was when Hank Paulson and Ben Bernanke were trying to save the world. In other words, the VIX is right about where it was once we figured out they managed to do just that. It’s actually lower than it was most the time that any stock with “Web” or “e-“ in its name could expect a three-digit P/E ratio.

So why are so many people still so nervous?

The VIX tends to move in parallel with interest rates. As bond yields rise, there’s less of an incentive to take the risk of equity ownership when you can get solid returns with comparatively risk-free debt securities.

Bond yields rise in response to increases in the Fed Funds rate. The Federal Reserve resets this rate in anticipation of inflation. Raising the cost of borrowing reduces the money supply, so inflation can only erode the spending value of a dollar so far, or so the theory goes.

The Fed retains its 2% target rate for annual inflation over 2018. That’s low. To give an idea of just how low that is consider that inflation peaked in 1980 at 13.5%. Lesson #1 in getting a second term – don’t let inflation get to the double-digits your re-election year. That was all that was needed to end Jimmy Carter’s presidency. Candidate Ronald Reagan went on the air and asked America, “Are you better off than you were four years ago?” And that changed the whole political dialogue in this country ever since.

The worst inflation in U.S. history—Confederacy aside—occurred before we even had a Treasury. In November 1779, at the height of the Revolutionary War, the continental dollar reached peak inflation of 47% in a month. The definition of hyperinflation is price increases exceeding 50% per month.

So the United States avoided hyperinflation, but just barely.  Countries that lived through hyperinflation in recent memory wouldn’t recommend it. For example, Poland decided on “shock therapy” rather than a soft landing when that country traded in communism for a market economy in 1989. It was worth it in the long run, but one cannot simply dismiss the pain of 600% inflation. It would’ve surely been worse if the International Monetary Fund wasn’t there to provide some cushion. And of course there’s Zimbabwe, the poster child for bad monetary policy. From 2006 through 2009, the Mugabe regime continually failed to learn any lessons, and the inflation rate during that period can only be rendered in scientific notation.

So when you take a long, historic view of U.S. consumer prices, you’re left with the inescapable conclusion that we’ve basically been  spoiled rotten.