published: November, 01st 2016
By Rick Wedell, CIO
Weekly Update 11/1/16 – Volatility is back
I thought I would send around a quick note given that the S&P is down about 1.3% and the DOW has been off and on flirting with a 200 point loss (although now it is only down 135). As I’ve said before, the magnitude of this move isn’t all that shocking in the context of normal trading patterns, however it is a little jarring given 1) its direction and 2) how quiet we have been over the past couple of months.
The selloff today is driven, once again, by politics, as it appears that Trump has possibly climbed his way back into the race. For what it’s worth, fivethirtyeight.com, which I have cited here before, has shown a significant narrowing of the election odds ahead of next Tuesday’s election, with Trump now having about a 28% chance of winning, which is a better chance than the Cubs have at securing a victory in the World Series. Perhaps more importantly, at least for the time being, momentum appears to be on Trump’s side. The markets do not particularly like this incremental uncertainty, and equities and other risk assets are selling off as a result.
At the same time, the FOMC began their meetings today, and it is likely that we will get a relatively strong policy statement in support of a December rate hike once it is all over on Wednesday. As a result, treasuries have been selling off in anticipation of the higher rates – the 10 year is at 1.82 which is up about 5 bps on the day, and the odds of a December rate hike are now over 70% according to Bloomberg. This means that, once again, we have treasuries selling off at the same time that risk assets are selling off, so there are not too many places to hide as far as a safe haven from all of this.
The current narrative in the market, which is supportive of an end of year rally, goes something like:
This thesis is still generally intact, however I would note that there are some things like the Italian referendum which are not totally on people’s radar screens which have the potential to derail us. For those not aware, Italy will go to the polls on 12/4 to vote on a series of constitutional reforms which have been championed by their current Prime Minister, Matteo Renzi. While Renzi came to power with strong popular support as a reformer and outsider, he is also a staunch supporter of the Eurozone and Italy’s membership within it. When he first proposed the reform package, he claimed that he would resign if it did not pass, however he has since backed away from that claim. In any event, if the referendum fails, it is possible that he will be replaced and that a Brexit like vote on Italy’s membership in the European Union could be called for. I was discussing this with a friend who is a partner at a hedge fund in NYC over the weekend, and his comment was that “no one with any sense of the history of the Italian political process should have any faith in them getting this right.” Of course, I’m sure he is speaking his own book.
I mention the Italian referendum only to explain that there are any number of things that could derail us going forward, from Chinese economic growth to OPEC (FYI oil is now back down to $46.77 after peaking up around $51.83 on the heels of the original OPEC news). It is hard to get overly excited about a market whose primary virtue appears to be the sentiment that “well, at least nothing terrible is happening”, and in any event we still have a pretty hard ceiling at 2200 on the S&P. As a result, we are going to continue to maintain our relatively conservative stance in the Focus models, which generally flows through to our positioning in the Risk Pro. The VIX never reached our $12 buy target after flirting with $13, and is now up around $20, so we are going to revisit our buy / sell triggers to be a little more appreciative of a normal range.
Rick Wedell is neither affiliated with nor endorsed by LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. No strategy assures success or protects against loss. Investing involves risk including loss of principal.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors. The Chicago Board Options Exchange Volatility Index (VIX) is used by stock and options traders to gauge the market’s anxiety level and shows the market’s expectation of 30-day volatility