There are various parameters that were being used by analysts to measure the fear factor that gripped the markets in the year 2008, specially after the month of September when the rumors of financial institutions going down in the Western world started gaining ground and which culminated in the collapse of Lehman Brothers, a virtual nationalization of AIG and government funding of various financial institutions.
There are various measures that analysts use to gauge the fear factor. Some of them are given below and the movement of these indicates that fear has now gone out of the markets to a great degree. Whether we will see a return of Greed is something that has to be seen going forward.
There are various measures that analysts use to gauge the fear factor. Some of them are given below and the movement of these indicates that fear has now gone out of the markets to a great degree. Whether we will see a return of Greed is something that has to be seen going forward.
TED spread and other interest rate parameters
The TED spread is essentially the difference in the yields (i.e. interest rate in basis points, 100 basis points = 1 percent) between the three month US Government Treasury and the 3 month LIBOR (London Inter Bank Overnight Rate). The difference between these two indicate the risk averseness in the financial system and it is essentially the gap in the Bank to Bank borrowing cost vis a vis the safest (perceived) asset of US Government securities. After the collapse of Lehman Brothers this gap had shot up to nearly 5% as the yields on US 3 month Treasury bills fell to zero and 3 month LIBOR shot up above 5%. Over a period of time since then the 3 Month LIBOR has fallen to 1.10% and that on the 3 month US Treasury has risen to 0.15%, thus reducing the TED Spread to 0.9%. A TED spread below 1% is believed to prompt investment into risky assets which includes equities, emerging market bond and currencies etc. This indicates that money has now started to flow between banks where there was a total lack of confidence post Lehman Brothers collapse. Good results from Financial Institutions in the US are also helping this cause.
The amount of overnight cash deposited at the European Central Bank also has fallen to its lowest in six and a half months, a possible sign banks are opting to put their cash to work elsewhere rather than park it at the central bank.
The two-year U.S. interest rate swap spread, a key measure of broader banking and financial market stress, narrowed by around two basis points to 54 basis points. That’s within a few basis points of its lowest level since the global financial crisis erupted in August 2007.
Corporate bond spreads and spreads on CD’s have also come down sharply in the same time frame.
The amount of overnight cash deposited at the European Central Bank also has fallen to its lowest in six and a half months, a possible sign banks are opting to put their cash to work elsewhere rather than park it at the central bank.
The two-year U.S. interest rate swap spread, a key measure of broader banking and financial market stress, narrowed by around two basis points to 54 basis points. That’s within a few basis points of its lowest level since the global financial crisis erupted in August 2007.
Corporate bond spreads and spreads on CD’s have also come down sharply in the same time frame.
VIX
VIX, created by the Chicago Board Options Exchange in 1993, is the Volatility Index. It measures the market’s expectation of near term volatility as reflected in the options prices of S&P 500 stock index. The volatility index (VIX) is also a measure of fear in the system and a higher level indicates a higher fear level and indicates that investors at that time are willing to pay a higher premium to buy protection (in very simplistic terms). VIX had shot up to almost a historically high number in October/ November 2008. Just to put this into perspective we have to go into the historic context starting from the year 2007 to actually see how high the fear factor went up to. Right through the start of the bull market in the year 2003 VIX had never gone above a value of 37-38. In the crash of May 2006 also the maximum value it saw was just 24. In 2007 as the first signs of the mortgage and financial crisis in the US started to come up VIX went upto 37 in the fall of August 2007. However as the markets started falling in the year 2008 till the climax in October 2008 this index went up to as high as 89 and has now come down to 37 levels.
Technically the VIX index has fallen below the upward sloping trend line, which started from August 2008. If it stays below the value of 37.6 over the next couple of weeks it will indicate a strong return of confidence and could lead to strong funds flow into risky assets.
Technically the VIX index has fallen below the upward sloping trend line, which started from August 2008. If it stays below the value of 37.6 over the next couple of weeks it will indicate a strong return of confidence and could lead to strong funds flow into risky assets.
GOLD PRICES
Gold another safe haven investment has seen its prices falling by nearly 13% from the peaks of February 2009. In the same time the equity markets globally have rallied more than 30%. This also shows indications of the fear factor coming down. In the period of extreme fear from 24th October 2008 till February Gold prices had risen from $ 680 TO $ 1000 a gain of over 45%.
US Dollar Index
As fear grew globally and lot of emerging as well as emerged countries started falling into problems which includes Balance of Payment crisis as well as defaults there was a steady influx into US assets from the beginning of 2008. (The irony being that US was the main cause of the crisis). As a result the US Dollar appreciated by nearly 30% vis a vis a basket of currencies measured by the US Dollar Index. I have talked about the reasons for the Dollar up move in an earlier article (The Dollar Conundrum). However now there seems to be a clear weakness developing in this currency, even though the move cannot be conclusively called until and unless the US Dollar Index falls by another 5% and remains at those levels for at least a couple of weeks. This is something we have to watch out for.
The above factors indicate some sort of stability and reduction of fear. However whether Greed will come back immediately or will take some more time is something that we will see empirically over the next few months. The Morgan Stanley Emerging Markets Index has gone up from a level of 470 to 650 over the last six months. The key is to see if it is able to sustain above 600 levels for a couple of months. If this happens one will become reasonably sure that Greed and most probably a new bull market is starting off.
The above factors indicate some sort of stability and reduction of fear. However whether Greed will come back immediately or will take some more time is something that we will see empirically over the next few months. The Morgan Stanley Emerging Markets Index has gone up from a level of 470 to 650 over the last six months. The key is to see if it is able to sustain above 600 levels for a couple of months. If this happens one will become reasonably sure that Greed and most probably a new bull market is starting off.