Complacency is rampant right now, because global gamblers assume that central banks have this all under control. Central banks are not worried, because their record low interest rates have collapsed credit spreads giving the illusion of low default risk. It's a dunce feedback loop. Denial will now be put to the test...
IMF warns on monetary heroin overdose:
"The search for yield in a prolonged low interest rate environment has led to stretched valuations in risky asset markets around the globe, raising the possibility of sharp, sudden adjustments in financial conditions”
As we see, the Fed Financial Stress index works the exact opposite of how one would expect. When risks are running high due to loose lending standards and growing default risk, the model shows "low risk".
And then there is a sharp, sudden adjustment in financial conditions.
Getting back to the casino, the momentum trade is officially dead in every direction. Today, cloud internet stocks got pole axed by a warning from Workday.
"The analysts noted that software stocks have collectively pulled back more than 20% from their 52-week highs, but they said they still “see unfavorable risk/rewards for a lot of the high fliers in software.”
Every rally must end with the obligatory volatility compression to punish the non-believers. As we see in the chart below, the current volatility spread is the narrowest since September and before that one year ago at the top.
Which is why gamblers flooding en masse to "low volatility" recession stocks marks the endgame for this entire rally.
"Investors are losing faith in momentum and pouring billions of dollars into low-volatility stock funds, another sign of increasingly defensive posturing as market confidence deteriorates."
The terms "safe haven" and "low volatility" are now going to be put to the test:
"Wall Street banks have labeled them expensive, crowded and dangerous. Yet the boom in low-volatility stocks is intensifying."
the price-to-earnings premium for the (low volatility) investing style is at a four-decade high"
The top holdings for the low vol ETF are almost all Utilities
For the past two years, October marked the turning point for realized volatility
Global markets are a coiled spring
