Volatility and some predictions for the coming year.

Bill Gross's recent comments on the limits of asset pricing modalities are well-taken...in the sense that he is a wonderful bond salesman who typically has the macro movements all wrong.

http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2006/IO+December+2006.htm

Volatility is indeed descending into new lows, propelled by globalization, increased central bank transparency, and of course the growth of the catch-all category du jour, financial derivatives.

However, the supply and demand dynamics have changed as well...and these are not permanent. For example, debt market volatility has seen large players (Fannie, Freddie, other GSEs)exit the market for volatility, while writers of put options are everywhere. The same dynamic is noticed in the equity markets as well, with the VIX hitting all-time lows. Complacency is rampant, and the forward pricing indicates calm waters ahead.

The Recapitulator is not so sanguine about the coming months, and sees volatility spiking in February to levels last seen last May and June (VIX=20+). There are many reasons for this ("what happens when the stock market increases beyond its premium to bond yields on a forward earnings basis" is one question to ask), but one should begin looking at credit growth and household financial burdens. U.S. equity markets will resume its 10% growth drift in June.

The Recapitulator has been bullish on the dollar for some time. It took a beating late in the year (followed by the BOJ doing what it has always done: protect its export industry by weakening the Yen). The dollar will see gains in 07.

China looks wobbly. Massive income inequality (in a communist country), rampant foreign investment, blatant currency manipulation, and the same cronyism that was in place prior to the spectacular banking IPOs this year (which were dressed up by the government handing billions of foreign reserves to prop them up.)

The Recapitulator wishes everyone a happy holidays and a safe and healthy new year.