PMC Market Commentary: October 17, 2014
A Macro View – Volatility and Fundamentals
For much of the past year, markets have been calm. And for much of the past year, there has been a steady drumbeat of warnings that markets will not stay calm forever, and that the period of low volatility, low volume, and no real correction would not last. But until something happens, it hasn’t, and as much as people claim that they are prepared, when pandemonium ensues, many people still run screaming for the exits.
The past two weeks have witnessed a run on almost all asset classes: global equities have sold off hard, with some indices heading into outright correction (the Nasdaq briefly touched 10% down), and others such as the S&P 500 coming within a hair. The volatility index (the VIX) more than doubled. Equity trade volumes surged, and volume usually surges when traders, hedge funds and high-frequency algorithms combine to create rapid gyrations. Bond yields of perceived safe-haven assets such as U.S. Treasuries and German bonds dropped fast and hard, with the U.S. 10-year dipping below 1.9% when most had expected only a few weeks ago that the next major move would be toward 3%. Commodities fell; the price of oil sank, with West Texas Crude coming close to breaking $80, something that seemed very unlikely as late as Labor Day. And sovereign yields of countries perceived as riskier – Greece, Spain, and other peripheral countries – rose higher.
The proximate causes of these wild market moves were not entirely clear. In the space of a few days, the International Monetary Fund warned of zero growth and deflation in the European Union; the crisis in Syria worsened and the advances of ISIS appeared to threaten the Iraq government; and the spread of the Ebola virus to two healthcare workers in Dallas did little to calm nerves.
Yet most of these risks were well known over the summer and even before (though the spread of Ebola to the U.S. is new). The fundamentals of the global economy and of thousands of companies were the same in mid-September when stocks reached their high for the years and this past week in October when stocks touched their lows. What changed – sharply as it tends to – was sentiment. Fear and anxiety replaced complacency.
But fear and anxiety are not investment strategies. They are powerful emotions that lead to flight (given that there isn’t much to fight in the electronic world of trading). Sometimes such selling is warranted by a change in fundamentals, excessive risk taking, and overvaluation. Though there are many making those arguments about stocks today, there are compelling arguments that stocks, and especially U.S.-listed equities, are reflecting the positive economics and earnings of many companies. Indeed, the first slew of third quarter earnings, buried though they were in the market onslaught, have been quite positive, from Intel to the major banks.
Absent clear indications that global financial markets are about the freeze up, it seems more likely that the current sell-off and plunge in yields are a panic moment and a trading phenomenon and not a harbinger of a bear market in stocks or a new phase of the bull market in bonds. Panic and selling can, of course, take on a life of their own, and that is always a risk. But we have had a long period between corrections, more than two years, and while the past weeks may be unnerving, they are normal aspect of markets, even if they feel like unwanted roller-coasters when they arrive.
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