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Fear has been overcome, but confidence is still lacking

The Vix index is now down to 15, which is relatively low. It was as low as 11.2 in March 2007, before we knew that the housing market was unraveling. During "good times," the Vix likes to be a in a 10-15 range. So based on the today's Vix level, we can assume that the market has largely gotten over the fear that the Eurozone sovereign debt crisis would plunge the world into another Recession. As fear has subsided, equity prices have risen, and we're slowly approaching pre-recession levels for the S&P 500—another 14% and we'll be at new all-time highs for this broad measure of equity prices.

The market has climbed a huge "fear" wall of worry, but it is not very confident at all about the future of the U.S. economy. We can see that in the still very-depressed level of Treasury yields.

The two charts above make it absolutely clear just how depressed Treasury yields are today. Not only are 10-yr Treasury yields almost as low as they have ever been, they are as low as they were in the depths of the Great Depression. And if that's not enough to convince you, I note that U.S. yields have almost converged to Japanese yields, which have been trading at extremely low levels for more than a decade, thanks to modest growth and zero to negative inflation. According to these charts, it's not unreasonable to think that the bond market believes that the outlook for the US economy is one of Japanese-style growth stagnation coupled with extremely low inflation.

So the message from the prices of stocks and bonds is that although the market sees little chance of another major recession, the outlook for the economy remains dismal. I believe that 10-yr yields would have to rise to at least 3 or 4% before one could argue that the market was optimistic about the future. For now, pessimism continues to rule the day.


This chart summarizes the advances in both the Vix index (which has declined significantly) and the 10-yr Treasury yield (which to date has risen only modestly). Risk has dropped a lot, but confidence in the future remains very weak, and that is why the Vix/10-yr ratio remains quite elevated from an historical perspective. There is very little about this market that smacks of optimism. The main message is that fear and pessimism have declined, but that we are still a long way from seeing the market as being overly optimistic.

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