Are you really so sure about that?
A profound mood of certainty pervades financial markets these days, reflecting broad agreement among economists, traders and asset prices themselves that the economic outlook is clear and calm, fiscal policy on cruise control and central bank intentions well-communicated and fully understood.
For years after the financial crisis — deep into the period of economic recovery and re-energized capital markets that continues today — a thick fog of “uncertainty” was said to hang over investors, business people and consumers. This was always largely an excuse, a combination of wounded psychology, residual fear from the bust and confusion about future growth prospects and the effects of aggressive monetary-policy moves.
But it spoke to an abiding disbelief in the idea that things were getting better even as they were, and it meant stocks and other risky assets were attractive precisely because they weren't being embraced amid supposed “uncertainty.”
An October 2012 column here argued that “The era of uncertainty may be drawing to a close” and qualified as a maverick position at the time, right before a divisive U.S. election in the midst of fragile economic conditions. Since then, the Standard & Poor’s 500 index is up 33%, junk-bond yields have collapsed and anxiety about long-term fiscal deficits has largely evaporated.
Here’s a look at how thoroughly that mist of perceived uncertainty has been banished from markets:
The Economic Policy Uncertainty Index is an academic effort to measure lack of clarity about the economy. It combines the variation among economists’ forecasts for growth; oncoming potential changes in tax policy; and news mentions of “uncertainty” into a daily and monthly number.
After peaking in the 2011 debt-ceiling standoff, it hit successively lower peaks near the “fiscal cliff” deadline and during last year’s government shutdown. The 30-day average level has now dropped back to serene mid-2007 levels, well below the average uncertainty quotient since 1985.
A new CNBC Fed Survey of 40 Wall Street economists, fund managers and strategists showed forecasters assigning the lowest probability to a U.S. recession over the next 12 months since the survey began in 2011. The average probability given to the U.S. falling into recession in the coming year was 14.6%. While this is in synch with other gauges of recession risk, which are now quite benign, it also shows how ingrained the growth story has become.
An array of financial-market indicators evidence extreme calm and a pronounced willingness by global investors to bet on continued stability. The measured volatility in the currency markets, for example, has reached a near-seven-year low.
Investors, too, are demanding scant extra compensation for taking on more risk, as the “spread” between high-yield bonds and Treasuries has continued to sink dramatically.
Last week, French cable company Numericable completed the biggest junk-bond offering in history, raising $11 billion – 60% larger than the prior record, a $6.5 billion deal for Sprint Corp. (S) last year. Investors bid heavily enough for the debt that interest costs were lower than anticipated, between 4.875% for five years and 6.25% for 10-year notes.
Meantime, the government of Canada Monday sold a slug of rare 50-year bonds and was swamped with demand, issuing double the minimum amount targeted and pricing the ultra-long-term paper to yield a mere 2.96%. How confident do investors need to be to lend money at less than 3% for half a century?
More than $1 trillion in mergers and acquisitions has been announced this year – not including Pfizer Inc.’s (PFE) $100 billion hostile bid for AstraZeneca PLC (AZN) – and reached that year-to-date threshold at the earliest date since (once again) 2007. This, likewise, is clear evidence the professed uncertainty that kept CEOs nursing profit margins and hoarding cash for years has given way to confident predatory adventures.
Is it time to worry?
If a smothering sense of “uncertainty” represented a good investment opportunity, do all these indicators of broad certainty today mean markets are unattractively valued and vulnerable?
This all suggests that macro shocks – faltering growth here or in Europe, rapid shifts in central-bank expectations, a policy mistake in China, a sharp escalation of geopolitical strife, a financial “accident” somewhere in the world – would not easily be absorbed or shrugged off by markets now priced for smooth sailing.
Markets remained blissed out for years in the mid-2000s and mid-1990s, of course, earlier periods of high liquidity, lush corporate profitability, energetic financial engineering and a well-articulated Fed roadmap. Those periods ended in destructive financial storms, but they were long in coming after years of widespread certainty distilled into reckless overconfidence.
Even if the dangers of a shock or meltdown don’t appear acute, there’s no denying assets appear pretty expensive across the board (except in some troubled emerging markets). Unlike in 2011-2013, it will be hard to earn nice returns simply by betting the world economy is healing and the financial system stable.
The abundance of certainty as 2014 opened also helps explain the sideways, fitful, to-and-fro action in the stock market in recent months. Decent economic data was met with a bored shrug, and lots of good news was already priced into equities. In the case of the leading "growth-at-any-price" Internet and biotech names, nothing but years of great news was engorging their valuations before they retrenched by 20%-40% since March.
As Wall Street digests last year's surge, enters an often-weak period of the market's presidential-election cycle, adjusts to the methodical downscaling of Fed stimulus, watches a continuing slowdown in China and waits for some other energizing catalyst, perhaps this range-tracing action in the major indexes isn't so bad compared to that kind of alternative. With any luck, the localized damage in growth stocks and China in the markets will rekindle some of that uncertainty that was so helpful in creating better investment opportunities.