Fear factor fading from world financial markets

LAST Friday the Chicago Board of Trade Options Exchange Volatility Index fell to 13.36, its lowest level since June 2007. 

What on earth is that? And so what? The index is usually referred to as the VIX. It is also known as the ‘fear index’. It measures the cost of insuring US shares against losses.

Buy the VIX and any losses in share values will be repaid by profits on the VIX contract. 

If investors think the risk of losses in shares is high then the VIX rises, if they think the risk of losses is low the VIX falls. That is what it has been doing lately. The fear index is now at a level not seen since six months before the global financial crisis began. 

Why are share investors now less fearful than at any time since June 2007? There are many factors.  

The European debt problems won’t be resolved for years but a plan to manage the problem is coming together and gaining the confidence of professional investors that it will work.  

The European Central Bank has been the key player. In August it stated that the euro union was not reversible and the ECB would do “whatever it takes” to defend the euro. In September it announced it would step into the market and buy the bonds of indebted countries to reduce their borrowing cost.

There were conditions attached of course and the indebted countries have largely agreed to them, or renegotiated alternatives, which they are honouring so far. Last Friday the Greek Parliament passed a bill to greatly increase the country’s income taxes, as required.

In December the ECB was appointed the regulatory supervisor of all euro-area banks with governments and central banks handing over their power. This should ensure prudent future management of all Europe’s banks.

Even the speculators trying to profit by short selling and talking the market down are giving up. 

The US economy is still the biggest in the world and the most important for global economic health. Its recovery from its 2008-09 recession has been slow. Unemployment was 10 per cent in late 2009 and the economy grew 1.6 per cent in 2010-11. 

That is slowly improving. The US economy grew 2.6 per cent in the year to September and unemployment has declined to 7.8 per cent in December. The US Federal Reserve has provided much stimulus but we should see self-supporting growth in future. 

Official US interest rates are at extreme lows, 0.25 per cent per annum. The Federal Reserve says it will keep rates there until unemployment falls to 6.5 per cent. So borrowing for US consumers and businesses will be cheap for some time yet.  

In 2012 investors were concerned about a possible economic slowdown in China, and uncertainty around the once-a-decade leadership change. The new leadership team is now in place and has announced it is targeting 7.5 per cent growth this year. 

This is similar to last year’s growth rate so demand for Australian raw materials should remain strong. The Chinese  plan to spend less on infrastructure and work to boost internal consumer markets. Chinese household incomes and spending power are rising.   

Australian shares earned 19.6 per cent in 2012 (All Ordinaries Accumulation Index).

With the global economy set for ongoing improvement another strong return from shares and growth assets is likely this year - good news for superannuation funds and investment portfolios. 

Defensive investments are likely to make low returns. The RBA cash rate and interest rates offered on fixed deposits will both probably decline further.

It won’t be all smooth sailing for shares of course.  There is the US debt ceiling to negotiate. Tighter financial controls in Europe, while essential for the longer term, will retard economic recovery there. Overall, though, there is now much less to fear. 

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