Will the spike in volatility retreat in the coming trading sessions or is it here to stay? As I mentioned at the end of last year, the period of ultra-low volatility ended when the Federal Reserve started raising interest rates and reducing its balance sheet. One culprit for this spate in volatility is interest rates and their aggressive rise that began after the last Fed meeting on January 31st. Rising interest rates aren’t a bad sign for stocks but the rate of change is what can spook the stock market. In other words, gradual rises are “Ok” but spiking interest rates have the potential to wreak havoc on the bond market which we don’t want – think 2008. As we rolled into Monday, this fear percolated into aggressively selling stocks which largely drove the bus for much of this week.
So, let’s take a look at a chart for an index of ten year treasury bond yields. Below is an 8 year chart where each bar is one week’s worth of price action. The orange trend line was broken after the Presidential election, implying higher interest rates are coming. Again, it is the rate of change in yields which matters the most to the stock market, not the absolute rate. The stock market had some of its best years in the 1980s when interest rates were double digits, so keep that in mind. You can see in the chart below that the last several weeks have seen an aggressive move higher since the low last summer. So, maybe the stock market didn’t wake up to this little nugget of information until after the last Fed’s last meeting. This recent move higher in yields looks a bit overdone to me at this point so I would expect a reduction in yields short-term and then a move up to 3.05% over the next several weeks.
So, what does the chart of the stock market look like? The chart below is more busy than the one above but there is a lot more to consider. Below is an 18 month chart of the S&P 500 ETF with each bar representing one day’s worth of price action. You can see a visual representation of volatility by how wide these bars are in the chart. Look at the last 6 bars compared to over the summer and all of last year – there was no volatility! Not a normal market in my opinion. Anyway, read the points I have in the chart below, there is a good chance we put in a temporary low on Friday’s trading session. No guarantees, but the oversold readings on the RSI (Relative Strength Index) on the chart below may have made a good case for a bottom. The last time we saw a reading this low on the RSI was just prior to the presidential election and you can see what happened after in this chart:
One thing to keep in mind is that there are no signs of a recession or bad earnings from corporate America (we are still in earnings season). There is just cause to expect good things for the US economy in 2018 so keep liquid, hedge and trade when possible. Sometimes, volatility brings opportunity. By the way, “Aloha” can mean hello or goodbye so be open minded about the open on Monday.
Chart of the Week!
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Economic & Central Banking Snippets
- The Bank of England said it expects to raise interest rates in the U.K. at a swifter pace than it anticipated last year, responding to stronger growth in the global economy. The BOE’s message comes as investors worry that more rapid growth could fuel higher inflation and a more aggressive response from global central banks. Those worries have helped prompt selloffs in world financial markets this week. (FT)
- January’s worldwide PMI surveys indicated that the pace of global economic growth quickened to the fastest since 2014, as increasing numbers of emerging markets have started to join the developed world-led upturn. Notably, Chinese businesses reported the best expansion for seven years. Since early-2011, there have only been five months in which all major developed and emerging market composite PMI output indices have been above the neutral 50.0 mark. Four of these occasions have been in the past ten months, including January 2018. If the upturn in growth wasn’t enough to cast a hawkish hue (higher interest rates) over the PMI releases, the surveys also indicated an overall intensification of inflationary pressures. Recent months have in fact seen the most significant period of sustained selling price inflation since the global financial crisis. An intensification of price pressures signalled by the eurozone PMI sub-indices suggests inflation could pick up faster than many are expecting. Prices charged in Germany, for example, showed the biggest monthly increase in over 15 years. (IHS) Translation: interest rates are going higher all across the globe.
Market Snippets
- The ongoing controversy surrounding volatility exchange-traded products is poised to grow. On Monday, the VelocityShares Daily Inverse VIX Short-Term ETN XIV tumbled 14.3% on volume that was nearly quadruple the daily average and almost six times the trailing 20-day average, but that wasn’t the worst of it for the exchange-traded note. While U.S. markets close at 4 p.m. EST, index values for volatility products settle after-hours. The CBOE Volatility Index, also known as the VIX, ripped higher Monday night, sending inverse volatility ETNs plunging. Here’s the ugliness straight from the VelocityShares website: XIV’s closing price Monday was $99, but its closing indicative value was $4.22, according to issuer data. As of 7:12 a.m. E.T. Tuesday, XIV was sporting a pre-market loss of 84%. (FT)
- Back to the moon Elon Musk’s SpaceX opened a new chapter for the private space industry when it launched its first rocket capable of reaching the moon, laying the groundwork for interplanetary travel. SpaceX hopes the new rocket pays its way by lifting heavy communication satellites into orbits around the earth and handling secret missions for the US Air Force. (FT)
- Amazon has announced the first major integration between its e-commerce operations and Whole Foods. Groceries from the chain will be added to Amazon’s (AMZN) Prime Now service in four markets – Austin, Cincinnati, Dallas and Virginia Beach – and the company plans to expand it across the country this year. Two-hour delivery will be free, while one-hour delivery costs $7.99, on orders above $35. (Seeking Alpha)
- One of the biggest U.S. gun manufacturers is taking steps toward filing for bankruptcy, according to Reuters. Remington has “reached out to banks and credit investment funds” in search of “debtor-in-possession financing” that would let the company continue operations once it went bankrupt. Remington’s sales plunged 27% in the first nine months of 2017, resulting in a $28M operating loss.
- The largest S&P 500 ETF (SPY) saw record outflows this week. Will there be inflows next week? Stay tuned. (WSJ)
That is all for now until next week’s Market Update. If someone forwarded you a copy of this report, you can sign-up directly at www.kiscocap.com.
Good luck out there!
Regards,
-Paul