“It's in literature that true life can be found. It's under the mask of fiction that you can tell the truth.” – Gao Xingjian

Sometimes, all you need is the turn of the calendar for stock market dynamics to dramatically change. Anyone vaguely aware of market movement this past week is seeing this first hand.  On the final trading day of 2014, the VIX index experienced it's largest one day percentage advance in history, with seemingly no one noticing. 

Out of the gate entering 2015, risk assets worldwide suffered heavy declines, followed by strong advances on Fed minutes, and ending with another large breakdown.  Importantly, the relationship of risk assets to Treasuries and defensive sectors began aggressively reverting to historical behavior.  Suddenly, the distortions and disconnects of the last year and a half seem to suddenly be going away.

This has been a week of Greek mythology for both the Phoenix and Cassandra. The mythical bird known as the Phoenix regenerates from his predecessors, arising from the ashes to be born again. The story of the Phoenix relates directly to investor complacency which kills the bird, and volatility which returns afterwards. Indeed with Quantitative Easing over, and undeniable proof that deflationary pressures are only increasing worldwide, the volatility phoenix is burning it's fire at the start of the year.

Yet, because of small sample bias, the availability heuristic, and representativeness, investors wrongly think the environment for stocks of the past year and a half has been normal. It simply has not when looking at quantitative models that analyze large cycles. The unrelenting decline in long duration government bond yields is a direct spit in the face of central banks who continuously use words to assure the markets that their stimulus is boosting inflation at economic growth.  People seem to think that what we have been pointing out regarding interest rate movement means we are “perma-bears,” completely failing to understand the historical relationships of bonds to stocks, and forgetting how bullish our approach turned us in late 2011 and 2012.