Why Investors Continue to Find Comfort in the Stock Market

The Dow dropped another 122 points yesterday, while crude oil jumped 5.4% to $103.41 a barrel and gold surged to a fresh two-month high. But that was before lunchtime in New York, when traders got the chance to talk things over and decide that widespread Middle East turmoil, bloodshed and coup d’états aren’t as bad as they sound.

Shortly after lunch, the mood on Wall Street reversed. Stocks rebounded. “Enough of this sturm und drang,” investors seemed to say to themselves. “By golly, we still love US stocks and we’re going to buy them no matter how many Middle East tyrants flee their countries!”

The Dow closed out the New York session with only a modest 37-point drop. The S&P 500 ended the day nearly unchanged and the NASDAQ Composite advanced about three quarters of a percent.

By contrast, crude oil’s early morning gains evaporated throughout the day. By the end of the New York trading session, the price of crude was down 82 cents to $97.28 a barrel – snapping a nine-day winning streak. The morning gains of gold and silver also evaporated, as gold slipped nearly one percent and silver tumbled nearly 5%.

“The worst is over,” Mr. Market seemed to say. He’s the expert, but we still don’t trust his judgment.

Earlier this week, the lovers of US stocks began noticing the serial “Facebook Revolutions” unfolding in the Middle East. These investors seemed to decide that the violent images on their TV screens that started pre-empting Jim Cramer’s “Mad Money” might mean something…perhaps something bad. So they decided to take a break from their habitual, manic stock-buying. The Dow dropped almost 200 points on Tuesday – its worst one-day decline since last summer. And the Blue Chips dropped another 100 points the next day.

The “Risk Off” trade was on!…at least momentarily.

Evidencing this momentary relapse into caution, the VIX Index stirred from its slumbers. This Index, known as the “Fear Gauge,” bounced a bit during the last few days. But at its highest point yesterday, the VIX had merely regained its average level of the last 12 months. And already, the index has slipped back below that average level.

Momentary Bounce in the VIX Index

Net-net, US investors continue to exhibit very little anxiety about stock price trends. They continue to cling to US stocks like a baby clinging to a “blankey.” Presumably, these investors consider the recent events in the Middle East to be of transitory and/or minor significance. By extension, the resulting spike in oil prices must be nothing more than a pothole on the superhighway to robust stock market profits.

Your California editor is not so certain that the “somethings” that are occurring in the Middle East mean next to nothing. Neither is he certain that the contagious revolutionary virus spreading throughout the region is bullish for anything other than the oil price…and Anderson Cooper.

Interestingly, some of the investors who are closest to the action seem to share your editor’s malaise. The cost of insuring 5-year government bonds issued by the State of Israel has jumped 50% during the last few days – the highest level in almost two years. By contrast, the VIX Index here in the US, barely reached its highest level of the last two months.

The Price of Insuring 5-Year Israeli Government Bonds Against Default

Perhaps these conflicting impressions of investor anxiety mean nothing at all. On the other hand, we would not derive any comfort whatsoever from the fact that investors over here scarcely acknowledge the risks that terrify investors over there.

Just sayin’…

Eric Fry
for The Daily Reckoning