Weekly Recap & Outlook – 08.17.12

Tower Private Advisors


  • Complacency increasing
  • Boring economics

This is self serving, but, oh well…


Capital Markets Recap

This has popped up in a couple of places recently. The Black Scholes and other option pricing models have a variety of inputs, some of which have to be estimated. By holding all other inputs constant, any one input can be estimated (i.e. implied). The most important determinant of option prices is volatility. The more volatility that is expected, the higher priced the option. Higher volatility is usually associated with a dicier outlook; lower volatility, with a more sanguine outlook. Here is a look at implied volatility for both U.S. stocks (specifically, the S&P 100 index of stocks) and the U.S. (technically, the Euro STOXX index.) Both show a level of complacency that is certainly not shared by our clients, almost all of whom are looking for dropping shoes.

This is what one might call a rosy consensus, and Warren Buffet has said that one pays a hefty price for a rosy consensus. Sadly, the price for this sort of outlook has historically been falling stock prices, as can be seen in the chart below. It’s the same as the one immediately above, except shown over the last two years, with the appropriate index overlaid in blue. Its message is that implied volatility at these levels has, in the past, been associated with prospectively falling prices.

In short, these two indicators are saying the coast is clear. Do you agree?

Top Stories

Running out of time on this Friday afternoon, so here’s a list of headlines I’ve accumulated from this week. My takeaways and/or sarcastic comments follow.

  • Finland gets ready for possibility of eurozone breakup
  • Sales of high-yield bonds reach record high – the search for yield is likely to end badly…sometime 
  • N.Y. Fed discovers many unreported municipal bond defaults
  • Spain and Italy have ability to meet debt obligations, study finds
  • Europe’s corporate-credit market shows apathy toward risk
  • Investors are ramping up stock positions Bank of America survey finds – the coast must be clear
  • 81% of financial advisors want Romney as U.S. president
  • First Trust rolls out dividend-oriented index ETFs – hey, have you heard that dividends are higher than bond yields?
  • Prosecution for financial crisis unlikely after Goldman dodges bullet – no kidding; they always do
  • India is powerless to stimulate growth, central bank chief says – inflation always limits central bankers’ options
  • Groupon shares drop 18% amid news that Q2 sales fell short
  • France sees decline in borrowing costs – if F(rance) fit into PIIGS better, it would be there
  • Sage Quant aims to launch low-volatility, dividend-focused ETF – oh, hey, better get some dividends
  • G-20 and U.N. ready emergency action on soaring food prices – I’m guessing there’s a positive correlation between food prices and civil unrest
  • Investment grade corporate-bond sales set record for July – see search for yield comment above
  • John Hancock seeks SEC approval for global multi-asset ETF – flavor of the month

This Week

The current bout of deflation continues on, as evidenced by year-over-year figures from the Consumer Price Index and the Producer Price Index, both on display in the chart below. The former is back to beginning-of-the-year levels, while the latter is back to late-2009 levels. The red lines indicate the zero point, below which prices start to fall. What’s depicted currently is prices rising at a slower rate. This is a pretty good place to be. With inflation well below the Fed’s Target Rate of 2.00-3.00%, the Fed has room to engage in reflationary policies before inflation is pushed unacceptably high. On the flip side, the closer we get to the zero line, the more worried the Fed gets. At present, there’s no reason for you to postpone purchases of goods, as this data indicates prices will be higher in the future; you’re better off buying now. When we cross below the zero line, however, you are better off waiting to buy stuff since it’ll be cheaper in the future. Imagine what would happen to our economy if we all knew that prices would be cheaper on September 1. Except for staples, like food and gasoline, we would buy very little, and the economy would come to a screeching halt. That’s what’s wrong with deflation and lower prices, and deflation will turn the average Federal Reserve Board governor into a quivering mass. I have never seen minutes from the Federal Open Market Committee, the one that raises and lowers the Federal Funds rate, that include the word “deflation.” Somehow, they’re almost afraid that the mere mention of it will produce it.


There were a couple of spooky regional reports that came out this week. First off, the Philly Fed report, issued by the Philadelphia Federal Reserve, showed a regional economy that contracted, but at a slower pace than last month. Economists were disappointed, however, as they had expected a better showing. The Empire State Manufacturing Survey, however, was far worse than last month and the average economist’s estimate. Both are in negative territory as they tend to be from time to time. Prolonged visits, however, tend to be associated with recessions.

Here’s the rest of the week’s economics:

  • NFIB Small Business Optimism – unchanged, subdued
  • NAHB Housing Market Index – rose to 37; best level since 2007
  • Initial Jobless Claims – virtually unchanged; still about where it started the year
  • Housing Starts – worse than last month (-1.1%)
  • Building Permits – better than last month (+6.8%)
  • University of Michigan Consumer Confidence – better than last month; better than expected; still stuck in 70s

Next Week

Key indicators to watch

  • Minutes of FOMC Meeting
  • Initial Jobless Claims
  • Durable Goods Orders

Housing related indicators

  • Existing Home Sales
  • New Home Sales

Graig P. Stettner, CFA, CMT

Chief Internet Officer

Tower Private Advisors


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