That's the public service message from the world's Central Banks to all of us in the general public, and especially to Wall Street.
When Bernanke embarked upon Quantitative Easing, three years ago in early 2009, he said at the time that the new policy (of printing money) would have unintended consequences. In Donald Rumsfeld's terminology, "unknown unknowns".
Fast forward 3 years, and some of those "unknown unknowns" have now become "known unknowns", albeit roundly ignored. Aside from having absolutely no exit strategy for all of this liquidity, which is the biggest known (but ignored) risk in this ongoing clusterfuck, the next major obvious risk is the collapse in "volatility" caused by these programs.
Volatility in the markets comes in two general forms - realized (actual) and implied (as priced into options). In normal times, when the market is not under stress, implied volatility tends to track recent actual volatility, because most quoted options prices are stubs generated by computer programs. When the 'shit goes down' so to speak, then fund managers reach for options protection and implied (priced) volatility skyrockets.
The issue with the QE programs is that they have pushed both realized and implied volatility to extremely low and artificial levels throughout the past 3 years. It's been month after month of metronomic rise - slow and steady, punctuated by two hair raising descents - the Flash Crash in May 2010 and the mini-meltdown of last Summer (2011). As I have indicated before, the market is not very efficient at pricing in these events, because implied volatility (as measured by the VIX index) actually falls as the market rises and then rises as the market falls ! Which means that options (insurance) gets cheaper as the market rises. This would be analogous to house insurance getting cheaper the closer we get to fire season.
In the chart below, I show the past 3 years with each incident when the VIX and the market diverged and then rapidly (unexpectedly) converged, as Wall Street unceremoniously shit a brick.
The key takeaway, is that today's divergence on the far right, is the widest in 3 years, as Wall Street has slipped into a liquidity-induced coma. So, anyone today who wonders why, given the worst economy in 65 years - supported only by government debt, with a European debt crisis getting worse with each passing moment, latent geopolitical risk in Iran, North Korea, Pakistan, Afghanistan, Iraq etc. etc. - why then is the market so complacent? The reason is because the incentives are in place to ignore risk (thanks to copious Central Bank liquidity).
The feedback loop between these liquidity programs and risk premia is that as the market rises in its slow but relentless fashion, as I noted, the VIX falls, because actual volatility falls which feeds back into options prices. Hedge Funds are now losing money two ways - one because the market is moving higher and a part of their capital is allocated to their hedge (put options) and also because the value of those put options is collapsing along with the VIX. Therefore, hedge funds have extreme incentive to underfund their hedges or they risk continued underperformance relative to the market, which will cost them capital and/or their investors.
Now, as we approach the next inevitable "Lehman Moment", you can see in the chart above, the actual 2008 Lehman moment on the left with the mega VIX spike. What you see in that timeframe is a market sloping downward from 2007, as it first copes with the Bear Stearns failure and the ongoing subprime crisis - a relatively controlled downward glide path that gave investors time to prepare themselves for the worst. Now, look at today's market which is not sloping downward, but rising to the upper right, as risk after risk is ignored despite now involving sovereign nations on the brink on failure, as opposed to individual investment banks i.e. the risks are greatly magnified, yet as we see, investors are blissfully oblivious to the risk.
Just today, I saw this article from a Momentum Trader saying that even though the fundamentals (aka. the economy) are undeniably deteriorating, a lot of stocks are performing well, so ignore the risk. This just serves to confirm that Wall Street is being paid to look the other way to mounting risks. The other problem is that Wall Street is dominated by short-term traders, who trade on the :15 minute boundary and won't hesitate to flip their entire portfolio from bullish to bearish with one large (short) S&P Futures trade. Therefore, their opinions of the market are of no relevance to anyone who holds stocks overnight, much less someone who actually owns stocks long-term.
Similarly, how about these investment advisories that in addition to offering 'Mutual Funds, 401ks, and Insurance", are now marketing "Hope" as well. Hope as an investment strategy? Are you kidding me? That's a new low even by the Idiocracy's standards ! Can you imagine the internal product launch: "Bob here, who you know as former head of our insurance division, is going to manage the new 'Hope' division. It's our initial foray into the Fantasy-themed marketplace which as we all know is growing astronomically...".
Sadly, given that pretty much ALL investment advisors drink the same Kool-Aid from the same source i.e. Infotainers on CNBC, I expect that these new "hope"-based products will have the same shelf life as a Wall Street market prediction i.e. :15 minutes.
