Weekend Reads for Investors: Volatility and the “Yellen Put”

Up until last week’s wild ride for stocks, volatility had been largely absent from the market and far from the minds of investors. However, the cumulative effect of ongoing geopolitical chaos, spreading Ebola anxiety, and uninspiring economic data, combined with the rumored unwinding of some leveraged positions by hedge funds, served to at least temporarily jolt global equity markets. Complacency was quickly replaced with panic and we got a reminder of what happens when everyone heads for the exit at the same time.

In the United States, the Chicago Board Options Exchange’s SPX Volatility Index (VIX), which earlier this year had been trading at a seven-year low, spiked nearly 70% over the course of the week, and the S&P 500 Index (SPX) dropped over 9% from its high the previous month. BlackRock chief investment strategist Russ Koesterich, CFA, who recently predicted that volatility would rise and “the smooth ride for equities [come] to an end,” proved prescient.

During the tenure of former chairman Alan Greenspan, the US Federal Reserve Board’s monetary policy included the implicit understanding that the Fed would step in to provide liquidity in times of market crisis. This became known as the “Greenspan Put,” and it was put into practice at various moments of extreme market stress, beginning with the stock market crash of 1987, and more recently as the “Bernanke Put” in response to the global financial crisis.

Critics have long charged that such repeated central bank interventions have created a moral hazard for investors — a tendency to take undue risk due to a belief that any negative consequences will be borne by others. In case there were any doubts of the existence of a “Yellen Put” under current Fed leadership, James Bullard, head of the Federal Reserve Bank of St. Louis, put them to rest when he suggested, at the depths of the recent sell-off, that the Fed might reconsider ending its latest quantitative easing campaign. In response, the VIX, Wall Street’s so-called “fear gauge,” quickly retreated and US stocks rebounded sharply, as did their European counterparts upon similarly supportive statements out of the European Central Bank.

A well-worn stock market adage says, “Trees don’t grow to the sky.” This remains true despite the best efforts of central bankers.

Below are some other stories that caught my eye in recent weeks.

Strategic Thinking

• GMO’s James Montier calls shareholder value maximization “the dumbest idea in the world”: (2014 European Investment Conference)
• Keith Ambachtsheer makes “The Case for Long-Termism” (Rotman International Journal of Pension Management, PDF)
• AQR’s Cliff Asness revisits his 2010 warning of inflation risk, issues a “half mea culpa,” and takes a few jabs at Paul Krugman in the process. (Real Clear Markets)
• “No Smoke, No Mirrors: The Dutch Pension Plan” (The New York Times)
• “Keynes the Investor: Lessons to Be Learned” (2014 European Investment Conference)

Behavioral Matters

• Nobelist Robert Shiller on the market impact of “thought viruses.” (The New York Times)
• “Facing Down the Narrative Fallacy” (The Psy-Fi Blog)

Emerging Markets

• “Rebooting India” (Asia Asset Management) 
• “What’s Next for China and India?” (2014 European Investment Conference)

Shareholder Values

• Are share buybacks coming at the expense of jobs, investment, and growth? (Financial Times)
• “Why Employee Satisfaction Matters to Shareholders” (Knowledge@Wharton)
• IBM’s stumbles are attributed to its focus on financial engineering. (The New York Times)

Big Business

• Justin Fox says it’s all about the cash flow at Amazon. (Harvard Business Review)
• In “The Empire Reboots,” Bethany McLean examines the future of Microsoft under Satya Nadella. (Vanity Fair)

High Profiles

• Craft beer pioneer Jim Koch is “The Steve Jobs of Beer” (The Atlantic)
• Nelson Bunker Hunt, tycoon, 1926–2014. (Financial Times)

Pork Barrel Politics

• Taxpayer-funded rabbit massages and synchronized swimming for sea monkeys are among the highlights in Senator Tom Coburn’s 2014 Wastebook (PDF).

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