Volatility Is Back
“Don’t just stand there…do something” has changed to “don’t just do something, stand there”. For a trader, the last couple of weeks have been heaven. For long-term investors, it has been a bit queasy, as worries about a much larger decline pop back up. The now daily 100+ point swings in the Dow have been attributed to everything from the Fed stopping their Quantitative Easing (QE) in October, to the potential for a long Middle East involvement by the military to Bill Gross leaving PIMCO. While the last one is not likely a top 10 reason, many of the others put forth are nothing more than speculation at best. Little has changed from an economic perspective, as growth remains modest, inflation contained (for now) and interest rates likely to remain relatively low well into 2015, if not longer. The end of the month and quarter usually give rise to intense trading as managers want to make their portfolios look nice for client reporting. But that also means the usual beginning of the month deluge in economic data, from employment to business conditions. Once through that data, company earnings season will begin the following week. Best to watch nature’s wonders in the coming few weeks rather than the daily bumps and grinds on Wall Street.
The short-term picture of the market is likely to be somewhat bleak in the coming weeks as the broad averages have held close to all-time highs, while many stocks are languishing. This divergence between the “generals” (SP500) and the “troops” (individual stocks) has been theme within the markets for the past two months. Small stocks, as measured by the Russell 2000 have performed poorly compared to the SP500. International holdings have been hurt by the surging dollar as investors flock to generally higher yields in the US and the safety of the US markets. Worries about an October plunge make their annual visit to investor’s psyche as well. Although it should be noted that last week, from strictly a historical perspective, is among the weakest of the year. Stocks are likely to struggle in the weeks ahead as investors sort out the economic data, corporate earnings, global conflicts and a mid-term election in the US. All that being said, the drivers for a serious decline of 10-15%+ have not yet shown up in the economic data. Until we see anything different, expect that stocks will be volatile and maybe lower in the weeks ahead, but not enough to derail the current bull market.
The more volatile the stock market, the more money flows into the safety of bonds. Just as the Fed is set to end their QE policy in October, rates continue to decline to the lows of the year. If the Fed is stopping their purchasing, where is the demand coming from? It seems everywhere else around the world. The yield on US treasury bonds, even at today’s low rates, is still higher than other sovereign debt. The rise in the dollar over the past few months has made it that much more profitable for foreign investors to put their money into dollar denominated bonds. The big decline in commodity prices over the past quarter, reducing inflationary fears, has also helped in keeping bond yields low.
Coming into the last two trading days of the quarter, the SP500 is up just over 1% since the end of June. The long and not so hot summer has seen some large shifts in the makeup of the various industry groups. Energy was leading the markets during the first half, but took the booby prize this quarter, down just over 7%. Surprisingly too were the utilities, usually a good performing sector in a declining interest rate environment, but they too were significantly lower for the quarter. The winners were technology and healthcare, although both have suffered over the past two weeks. Among the larger asset classes, real estate was looking very good for the quarter until mid-September when the wheels came off. As with utilities, REITs tend to move with bond prices, as bond prices rise (and yields fall) utilities and REITs also rise. This recent disconnect is something worth watching for clues about both interest rates and the risk appetite of investors through the final quarter of the year.
The cheese (SP500) stands alone in the performance derby in the third quarter. International fell as the dollar rose and interest rate sensitive sectors fell even as interest rates declined. Commodity prices may be the key, as strong declines may fan fears of a deflationary environment that keep Fed officials worried. The bond market is playing right along and not at all worried about the ending of QE policy. Expect continued volatility for stocks, while bond prices may still have some room to rise in the weeks ahead.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.