PMC Weekly Review - August 28, 2015

Ground Hog Mon-Day: Has the U.S. Economy Seen Its Shadow?

Following a tumultuous week in the markets, many investors are asking themselves whether the sharp drawdowns experienced earlier in the week mark the beginning of a recession, or merely represent a great buying opportunity. As I sit here watching the indices move up and down nearly in tandem, Warren Buffet’s sage words come to mind, “Be fearful when others are greedy and greedy when others are fearful.”

The VIX crossed 30 on Monday, reaching an intraday high of 46.34 before finally closing at 43.26. It has since retreated, but has hovered around the 30-mark for the remainder of the week. Widely considered an indicator of the fear level in the markets, the VIX offers observers a glimpse into the number of investors purchasing protection against market declines. The higher it trades up, the greater the fear of market participants. Contrarians largely interpret it as a positive signal when it trends above 20, and 30 is often thought to be a positive indication of the market’s trajectory for the next six months.

And yet, a great deal of uncertainty still surrounds us. What of China? What of the turmoil in Greece? Will the Fed move forward with raising rates amidst all the global uncertainty? Although a rate hike from the near-zero rate environment that the U.S. has been operating in is inevitable, September now seems unlikely. On Wednesday, Federal Reserve Bank of New York President William Dudley described the probability of a September hike as “less compelling.” Even withstanding a rate hike, monetary policy in the U.S. and Europe remains very accommodative. And, although China’s slowdown and currency devaluation have been center stage for the past few weeks, the fallout appears to be fairly self-contained. China is an exporter (rather than an importer) to most major economies, and Chinese consumption accounts for less than 1% of U.S. GDP exports. And Greece, whose economy is the size of Detroit, is even less consequential.

With 2008 still fresh in investors’ memories, it is no wonder that Monday felt like a sort of doomsday—the Dow posted its largest ever intra-day index point decline, and many ETFs fell between 30%-50%. However, we can take comfort in that markets have already started to reverse course. Housing data shows that U.S. home prices still are rising at a moderate pace, and new home sales posted a new seven-month high in July. U.S. GDP growth expanded 3.7% in the second quarter, well above the earlier estimate of 2.3%. Initial Jobless claims fell to 271,000 from 277,000 the week prior. The major indices traded up on Wednesday after several positive business readings following a six-day losing streak: the S&P 500 gained 3.9%, the Dow increased 4.0%, and the Nasdaq soared 4.2%. Thursday’s strides also were positive, although Friday’s open subsequently gave back some of these gains.

And yet, I would be remiss if I failed to point out that amidst the short-term volatility, certain strategies fared better than others. Following a six-year bull market, alternatives largely have fallen out of favor. However, this week’s events have reinforced the importance of diversification within any portfolio. Several alternatives and trend-following strategies profited this week, partially insulating portfolios and dampening the effects of short-term volatility for those investors who were diversified properly.

Monday’s performance is a good example. In contrast to significantly larger losses in the equity markets (S&P 500 -3.9%; Dow -3.6%; and Nasdaq -3.8%), alternative strategies were down, on average, only a fraction of their broader market peers (HFRX Global Hedge Fund Index -1.1%; HFRX Equal Weighted Strategies -0.8%; and HFRX Absolute Return -0.2%)—reinforcing the value behind less-correlated sources of return.

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