The 'Old Normal' Stirs From Its Slumber
Can the old normal replace the new normal? Ben Bernanke seems to think so.
Quantitative easing -- evidently on its way out -- is a creature of the new normal, and QE of course is an unusual and highly invasive response to an extended period of low economic growth. By putting an end in sight, the Fed is saying that the "old normal" -- better growth rates and a diminished role for government intervention -- has a shot at a comeback.
One companion of the old normal resurfaced this past month: volatility. The VIX -- known more formally as the Chicago Board Options Exchange Volatility Index -- moved substantially higher than it's been in a while. While the VIX measure most commonly cited reflects the "spot," or current, measure of volatility, VIX futures matter, too, since they reflect future expectations for volatility. A month ago -- when Bernanke first suggested that the beginning of the end of QE might be nigh -- the spot VIX was about 14, substantially below its long-term average of about 21. Even then, futures contracts showed that the market expected volatility about six to eight months out to rise toward that long-term average, a sign that traders weren't expecting the low volatility to last much longer.
Bernanke's revelation last week that the Fed is in fact planning its monetary-stimulus reduction drove the spot VIX rate back up toward its long-term average. Futures expectations barely moved, however, because traders had already concluded that a return to the old normal was in progress.
A rising VIX isn't the only thing signaling the return of the old normal. There's also the reappearance of positive "real" yields, which are calculated by subtracting the annual rate of inflation from the yield on bonds -- say, 10-year Treasuries. The math is straightforward: inflation rates in the U.S. over the next few years are expected to be in the neighborhood of 2 percent, not coincidentally right where the Fed wants them to be, while 10-year Treasury yields are up sharply to about 2.5 percent lately. It's the first time in a long time that real yields have been positive.
Bernanke always shrewdly qualifies his thinking by saying it's shaped by whatever the economic data continues to tell him, but he does seem to believe in the return of the "old normal" enough to consider weaning the economy off QE, his signature new-normal program.
Even taking into account the recent surge in the VIX, U.S. stocks are still likely better-positioned than their counterparts in other developed markets. After all, it's a lot tougher to make an argument for stocks in Europe and Japan, where markets are going through such throes of deregulation that the road back to the old normal there may be rougher and longer.
Oh, and one other thing about those positive real interest rates: They're still very low by historical standards. That puts bonds at risk, which means stocks are relatively attractive.
Simeon Hyman is Chief Investment Officer of BloombergBlack, a new offering available by invitation to affluent investors looking for a smart, easy way to take control of their personal wealth. For more information, visit BloombergBlack.
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