Volatility Reversal | March 18, 2022 - Financial Future Services

TITLE: INVESTMENT ADVISER REPRESENTATIVE

TAGS: S&P 500, NASDAQ, Yield Curve, FRB, Rates, Nvidia

The monitor flashed quite a bit of red last month. But the market was seemingly undeterred and pushed higher anyway. Should this continue?

Fixed Income: 2-Yr Treas Yield 3.91% | 10-Yr Treas. Yield 3.91%

The bond markets saw volatility in August as questions mounted about an impromptu rate-cut by the Federal Reserve Bank (FRB). The most meaningful fall came at the beginning of the month. The perceived weakness in jobs data prompted a move to safety as expectations increased for a rate cut. At the time, people were calling for 0.50% before the September meeting. Cooler heads prevailed and the market is now expecting a 0.25% cut in September. The more impressive data point over the last month was the parody reached on the last trading day of August. This was the first time the two closed at parity since July 5^th, 2022! It is still to be determined if rate normalization (higher rates on longer dated fixed income) will prevail. It is a good sign that the anticipated rate cuts are making a large enough impact for us to reach parity.

Equities: Dow Jones 1.76% | S&P 500 2.28% | NASDAQ 0.65%

The market moves that led to a strong month for fixed income signaled weakness for the equity markets. The Nasdaq lost almost four percent in the first week of the month to spend the next two weeks crawling out of that hole. The last week of the month saw the index continue to falter. Strong earnings from bellwether Nvidia (NVDA) was not enough to bolster confidence. Investors seemed to come to the realization that the FRB will likely take a slow methodical path towards rate reductions. That path did not buoy equity markets. In a retracement of the July trades, other major market categories failed to capitalize on weaker large caps:

S&P 400 (Mid Cap Index): 0.21%

Russell 2000 (Small Cap Index): 1.59%

Conclusion

It was, in all, a good month… That’s for two reasons, 1) fixed income made up ground that equities lost, 2) the spread between the 2-yr treasury and the 10-yr treasury reached parity. Something of a signal that the soft landing the FRB is looking for has been achieved. Generally, a recession (that would be evident by this point) would have caused a normalization of the curve.

A Look Ahead…

We see two key reasons to expect further volatility in equity markets during the next month:

The 22.40 price to earnings (P/E) ratio for the S&P 500 will need to narrow further before markets can start a real rally.
September is notoriously the worst month of the year for equities:
- 2023: 5.35%
- 2022: 8.92%
- 2021: 4.89%
- 2020: 4.12%
- 2019: 2.32%

Some logic would point to the high frequency in recent years being a signal that volatility should weaken in September. I find that unlikely given the elevated P/E referenced.

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Last week, there was a reversal of course for volatility. This led the NASDAQ 8% higher. Is there volatility risk ahead?

Monday S&P 500 0.74% | NASDAQ 2.04%

The markets opened with a bounce as oil prices continued their retreat from recent highs. Unfortunately, the bounce was short lived. The markets reacted to word that President Biden would be making a trip to the EU. The trip is to discuss a fourth round of sanctions against Russia. Additionally, China announced a lockdown for 50M people as a spread of COVID cases persists.

Tuesday S&P 500 2.17% | NASDAQ 2.93%

Oil prices retreated on Tuesday, falling below $100 a barrel. This move created optimism on equity markets that the inflationary impacts from oil will be short lived.

Wednesday S&P 500 2.24% | NASDAQ 3.79%

Markets opened sharply higher as anticipation of the rate hike later in the day was baked in. Additionally, news broke of a potential light at the end of the tunnel for the turmoil in Ukraine. Putin made statements that a Ukraine that was neutral but maintained a military could be a path forward. Oil prices fell in response.

Thursday S&P 500 1.23% | NASDAQ 1.33%

The rally continued to push markets higher. This marks the third day of growth. Early trading was choppy, but the markets picked up steam as the day wore on. The market surge occurred while WTI Crude Oil crossed back over $100/barrel. The inflationary effect oil has on the economy would deter stock market growth.

Friday S&P 500 1.17% | NASDAQ 2.05%

Markets climbed even with oil sustaining at $100/barrel. While oil sustained their levels, they didn’t rise as they have as of late. The sustained level is not ideal, but better then an advancing oil market. Interest rates on the year treasury fell on the sustained equity rally.

Conclusion S&P 500 6.20% | NASDAQ 8.59%

Beginning on Tuesday, markets surged throughout the week (even as the Federal Reserve Board (FRB) initiated lift off). While the initial hike was a mere 0.25%, the increase was a measured response that was received well by investors. Investor reaction after having a weekend to mull the FRB strategy will be an indicator of future weeks. A strategy that could see hikes at almost all of their remaining meetings.