Remember just two weeks ago when all the talk was about the end of the cycle? How this was as good as things were going to get? About how profit margins had peaked? Today? Well, we’re knocking at the doors of those highs again.
On the surface, nothing much happened in U.S. stocks today. The Standard & Poor’s 500 stock index closed up 0.33% for the day. Ho hum. But intraday the S&P 500 showed an entirely different story.
It’s only March but I’m rethinking my take on 2018.When the calendar pages turned over into 2018, my take on the year was that for stocks the first half would be much like 2017: Despite rising interest rates from the Federal Reserve, there was enough earnings growth to move stocks up even from near record highs. The bond market would be more problematic with those interest rate increases keeping downward pressure on bond prices and upward pressure on bond yields. With inflation still relatively quiescent, though, the downward trend in bond prices would be relatively gradual. It was the second half of the year that investors had to worry about, I thought then.
This week investors and traders have been treated to one of the most difficult kinds of stock markets to navigate–the news-driven, trendless market. This week the downward direction of the market has been in reaction to the President’s announcement of tariffs on imported steel and aluminum. Next week the market could reverse if President Donald Trump changed his mind. Or it could sink further–and quickly–if nations such as China and Brazil and nation-groups such as the European Union decided to implement retaliatory tariffs
Yesterday, U.S. stocks moved higher in the morning and then continued upward until traders and investors had a chance to think twice about the minutes from the Federal Reserve’s January 30-31 meeting.
Before this market rout and from the safety of the World Economic Forum in Davos, hedge fund legend Ray Dalio talked about the coming bear market in bonds and likelihood that we were near the end of this cycle of economic boom. Sometime in the next two years, he remarked, we were likely to experience a recession and that would put an end to one of the longest periods of economic growth in the United States. With the experience of the big market rout of January 26 through February 8 behind us–if it indeed is–when the Standard & Poor 500 stock index fell 9.03%, I’d like to make Dalio’s comments a little more explicit and apply them more directly to the stock market.
Investors and traders don’t have just the volatility from the CPI inflation report tomorrow to worry about. An unexpectedly strong or weak inflation report could send stocks and bonds soaring or tumbling. There’s also the expiration of options on the CBOE S&P 500 Volatility Index (VIX) tomorrow.
After getting their heads handed to them when volatility rocketed to 37.32 on the VIX on February 5 from 11.33 on February 1, low volatility traders were back today betting the the CBOE S&P 500 Volatility Index (VIX) would continue its fall from 25.61 at the close today. That’s another drop of 11.87% today. After that 230% move to the upside, which resulted in some low volatility ETFs recording 90% losses, the VIX is down 31.4% from its February 5 high.
The Standard & Poor’s 500 and the Dow Jones Industrial Average both finished in the green today, up 1.39% and 1.70%, respectively, after having held off a bout of selling around 3:46 p.m. New York time. Volatility also made progress on returning to normal.
As is so often the case, liquidity was the driver for Chinese stock today, Monday. The Shanghai Composite Index rose 0.78% to 3,154.13 points by the close of trading Monday, after initially falling 0.45% during the morning. Two indexes with more exposure to China’s smaller companies and entrepreneurial sector showed bigger gains. The Shenzhen Component Index rebounded by 2.91%, while the startup-heavy ChiNext exchange gained 3.49%
This week did brought attention to how spectacularly wrong a trading strategy that had bet that the prevailing low volatility continuing had gone wrong. The posture children for the blow up of this strategy was when two exchange-traded funds (ETFs) that bet on lower volatility, VelocityShares Daily Inverse VIX Short-term Futures ETN (XIV) and ProShares Short VIX Short-term Futures (SVXY,) fell about 95%. But the implosion of these two ETFs is just the tip of the low volatility debacle that unfolded this week. And that helped drive volatility in during this correction.
Once upon a time, before the U.S. stock market moved into an actual correction and before bond yields spiked, the Federal Reserve was clearly on track to raise short-term interest rates at its March 21 meeting. The debate in the financial markets was about whether the Fed would increase its benchmark interest rate three or four times in 2018. But then we got tax cuts piled on top of spending increases.
