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fear subsides, prices rise

I haven't posted this chart in a while, but I think it is significant that the story it is telling hasn't changed for the past two years: the ups and downs in the equity market are strongly correlated with the market's level of fear, uncertainty, and doubt (as expressed by the Vix index). The market went into a mini-panic last May, but fear is slowly dissipating, and prices are beginning to move back up. Why? Europe didn't melt down; commodities didn't collapse (in fact they are rising nicely); the U.S. economy hasn't double-dipped (in fact it is doing better than expected); and policy errors that could really threaten growth—like cap and trade—aren't happening.

The one cloud that remains on the horizon is the expiration of the Bush tax cuts at the end of this year, but the political winds continue to blow in a favorable direction on that score (i.e., the growing likelihood of big Democrat losses this November), and if more people can apply common sense, facts, and logic to make the case for not increasing taxes and instead for cutting spending, like Art Laffer does in his WSJ op-ed today, then investor confidence in the future could really start to improve.

The market is suffering from the "once burned, twice shy" syndrome. The majority of people are still terribly afraid that something else is going to go wrong with the economy. All it takes for prices to move higher is the realization that the market's worst fears aren't materializing. Now, if we could actually get some really positive news, imagine the upside potential!

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