Commentaries

PMC Weekly Review - March 10, 2017

A Macro View: Missing Volatility – An Opportunity to Reposition and Rebalance

Another week, another time when the equity markets refused to sell-off. And it was a week when, in past years, that might well have happened. A major new piece of legislation affecting a substantial chunk of the US economy was unveiled in Congress, and yet markets barely blinked. Having promised for years to repeal and replace the Affordable Care Act, the House Republican Caucus released its first draft of doing just that. At more than $3 trillion, American healthcare spending is a major portion of total economic activity (not to mention a core concern for all of us, regardless of economic and market impact). One might have predicted that a law designed to alter significantly how healthcare is paid for and delivered would have created some market volatility. But one would have been wrong.

The other ingredient for equity volatility should have been a slew of strong economic indicators, ranging from robust national and global Purchasing Managers Indices (PMIs) to a stronger-than-expected US jobs report. Although certainly good news for businesses and individuals, these data points also strengthen the case for the Federal Reserve (Fed) to move more quickly on its mild tightening-of-interest-rates path. Bond yields certainly rose on the assumption that the Fed will raise rates another 25bps in the coming weeks, and may follow with another hike by summer. As that will still leave short-term rates hovering around 1%, longer-dated bonds have experienced price declines and rising yields, with the U.S. 10-year Treasury Note surpassing 2.5%.

In many prior tightening periods, equities tended to be buffeted, as investors repositioned holdings and shifted among asset classes attempting to preserve gains, avoid losses, and plan ahead. But that too did not happen. Instead, whereas yields certainly showed an increase, equities unfolded with little volatility and a lack of panic.

The final element that might have produced some choppy waters was the sharp drop in the price of oil, as concerns of inventory gluts mounted. The price of a barrel of West Texas (WTI) crude fell below $50 for the first time this year, contrary to where more traders were seeing the market. That led to a slump in many energy and energy-sensitive names, but the overall effect on markets was muted. Yet another opportunity for volatility lost.

It would, of course, be unwise to assume that everything will remain stable and placid just because the normal ingredients for a market rollercoaster failed to produce it. Perhaps this is the calm before the you-know-what; perhaps markets can withstand a few hits, but those are weakening the foundations, and one more may result in the sell-off so many seem to anticipate. It’s possible, but the evidence suggests it’s not likely.

Even so, it is hard just now to see why markets would be fundamentally impaired. Yes, some volatility should be expected and planned for, but absent a sharp deterioration in corporate earnings and revenue outside of the energy sector, any sharp pullback likely would represent a classic buying or rebalancing opportunity for sectors and names that pass fundamental muster. In addition, it appears we are not at the end of rising short and intermediate US bond yields, though there is little indication that substantial inflation or rate levels commensurate with the 4%-5% average of the past few decades are on the horizon. For now, then, financial markets remain remarkably stable, which makes for an optimal time to position, rebalance, and act with calm decisiveness.

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Featuring

Zachary Karabell
Head of Global Strategies, Envestnet, Inc., Consultant to Investment Committee*

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