Central banks are running this market. It’s not real. It feels like a ghost town. But what are investors to do? Well, you may be aware that pensions are writing puts on volatility. In other words they’re offering downside protection to investors. Nice business in calm markets, but if the markets do go down, pensions will be on the hook. It’s yet another short-sighted view on the part of the so called fiduciaries. Yes, markets are calm. But as we enter the heart of hurricane season New Englanders and those who live on the Eastern Seaboard know it’s better to be wary of the calm and to be ready for the storm. As an investor, your financial survival depends on you being ready and you being patient while others are being antsy. I like what James Mackintosh of the WSJ writes here:
Wall Street has long seen central-bank action through the lens of the options market, since Alan Greenspan’s tenure as Fed chairman. The “Greenspan put” has under current Fed chief Janet Yellen become the “Yellen put,” named for an option used to protect against falling prices.
If the Fed offers free insurance, there is no point buying your own, which ought to keep the price of puts—that is, implied volatility—down.
Faith in how far central banks will protect against losses comes and goes, though. In market-speak, the Yellen put is less out of the money if a smaller price fall pushes the Fed to act. At the moment, investors seem to think the put is barely out of the money at all.
The danger, then, is not so much complacency about markets, but complacency about central banks. The lesson of the past seven years is that policy makers will step in every time disaster strikes. But investors tempted to rely on the central banks should note that disasters did still strike, and markets had big falls before help arrived. The time to buy insurance is when it is cheap, and for the U.S. stock market, that is now.