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Investment Commentary

“The Fear Index” and “A Gentleman in Moscow”

By Brian Schaefer | Johnson Financial Group • March 30, 2023

5 minute read time

Like many people in their 40s and 50s, I find myself saying the words “used to” a lot. I “used to” be able to break 80 on the golf course. I “used to” be a pretty good tennis player. I “used to” have a 32-inch waist. You get the idea.

I also “used to” read quite a lot—mostly novels for fun. In recent years, I have read less and less for pleasure and more and more for work. But a few weeks ago, I took my first extended vacation in several years and dedicated some time to reading for pleasure.

I started the book A Gentleman in Moscow, about a Russian aristocrat caught up in the Bolshevik Revolution and sentenced to a lifetime of house arrest in a Moscow hotel. The charming novel unfolds over 30 years, as Russia transforms itself at great human cost from a monarchy into the Soviet Union. The great storytelling combined with its relevance as we watch the war in Ukraine devastate so many lives was riveting. I couldn’t put it down.

Snow, Ice and a Banking Crisis

The day after I returned from my tropical vacation, I woke up to wind, snow, ice, and a banking crisis. Bank stocks were plummeting, and the bond market was more volatile than any time in my career save for the Great Financial Crisis (GFC). The two-year Treasury bond, guaranteed by the full faith and credit of the United States Treasury, with full taxing authority over a $23 trillion dollar economy, was whipping around like a penny stock.

This rude awakening from my vacation gave me cause to recall a different novel that I read way back in 2011 called The Fear Index. That book, written in the wake of the GFC, takes its title from the CBOE Volatility Index, or VIX, which measures volatility in the S&P 500. Investors often cite the VIX when assessing risk, or fear, among stock investors. In the novel, a brilliant scientist creates a super-computer using artificial intelligence which trades after analyzing market behavior and news stories, often predicting and capitalizing on the fear that comes from financial panics.

It occurred to me that if author Robert Harris was writing his novel today, he might need to abandon his references to the VIX and replace them with the index that measures bond market volatility. This index, called the MOVE index, measures volatility in the Treasury market. As you can see in Figure 1 below, Treasury volatility measured by the MOVE index has eclipsed that of the VIX over the past year and is far closer to its GFC peak than the VIX.

Total money market fund assets increased by $117.41 billion to $5.13 trillion for the week ended Wednesday, March 22, according to the Investment Company Institute [Figure 2].The volatility in Treasuries is not because they have become a credit risk. United States Treasuries remain the safest securities in the world. Rather, the combination of investors trying to anticipate the Federal Reserve’s next move combined with a flight to quality has resulted in disorderly trading of a staid asset class. A few weeks ago, investors expected the Fed to hike rates by a half percentage point. By the end of last week, the market was pricing in 3-4 rate cuts by year end. Further volatility should be expected as the Fed battles inflation while watching for signs of credit stress that would force them to pause or pivot to cutting interest rates.

Cash Investing

While investors are trying to figure out the Fed and the economy, money has been pouring into cash. Total money market fund assets increased by $117.41 billion to $5.13 trillion for the week ended Wednesday, March 22, according to the Investment Company Institute [Figure 2]. Government money market funds have seen the bulk of inflows lately as investors demand the safety of Treasury Bills and pull money from prime money market funds, which invest heavily in short-term obligations of companies in the financial services industry.

Treasury volatility measured by the MOVE index has eclipsed that of the VIX over the past year and is far closer to its GFC peak than the VIX.Money market assets have benefitted not only from fear and volatility, but also because of their fat yields, which are as high as 4.70%.

Lesson Learned

But before you call your advisor and ask him to put all your money in a government money market, I ask you to take a moment to think about The Fear Index and A Gentleman in Moscow.

First, look at the VIX index in the first chart above. Had you had the fortitude to invest in equities during those periods of stress in 2008 and 2020, you would have been well rewarded. Volatility is not a reason to sell an asset class and is in fact often a contrary indicator. Smart investors anticipate and capitalize on volatility.

Also consider the likelihood that we are much closer to the end of this rising rate cycle than the beginning. When the Fed pauses or pivots, declining Treasury yields mean higher bond prices and, over time, support to equities via lower costs of capital and higher expected returns. As cash yields erode, money will flow back into stocks and bonds in search of a higher return.

Finally, for those of you justifiably but perhaps overly concerned about our financial system and political climate in light of the stress in the banking system, I ask you to take a moment and think about what you love about this country and why I believe it is a great place to invest, start a business, and raise a family. One of the fascinating but horrifying things to me about the history of Russia as so well told in A Gentleman in Moscow is the subordination of the individual to an ideology. I don’t see how anyone can have faith in a system that puts so little value on individual freedom and opportunity.

In contrast, in my job as a financial advisor at JFG I get to hear success stories every day of small business owners who came from nothing and are now helping their grandchildren go to college or giving back by mentoring young people in their field. Our clients are airline pilots, engineers, executives, teachers, and everything else you can imagine. They have the faith in themselves and their country to raise children and make plans for a better future because the inherent worth of every person and their ability to decide their own fate is a fundamental part of who we are. For that reason, as much as the market dynamics I’ve tried to explain in these paragraphs, I believe that clients can and should continue to invest with optimism. The American experiment won’t be derailed anytime soon.

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