A LITTLE VOLATILITY NEVER HURT ANYONE.

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A lot has now been written about the selloff markets are currently experiencing and the hyperbole is somewhat misleading.
Sorry folks, the Bitcoin crash is not the biggest ever just yet. The Dutch back in the 1600’s have that well and truly covered with tulips. Back then a tulip could go for as much as 12,000 Dutch Florins and the price on tulips collapsed to pretty much 1 Florin.

Given the spending power that one gold florin gave then, Bitcoin has to rise significantly by at least a factor of 100 before falling to almost zero to come close. Hyperbole. To be frank, its just a few folks who got carried away with a concept and paid too much. What were they thinking? Bitcoin traded today around the 7,500 level. The market appears to be heading in one direction as Regulators intrude, falsehoods are being exposed and credit card purchases of cryptocurrency is no longer being facilitated.

For equities, a little volatility does not hurt. The recent selloff is allowing investors to pause and actually think about an investment to make money. This is the time when money managers that are not index huggers can shine and earn their keep. For the index huggers, they can take the crumbs and the weaker returns. And for the index huggers, the market has not been kind.

The year’s gains have now dissipated in the blink of two days trading. Curiously, this is now three days of 1% movements in the year and demonstrates just how weird last year was which saw only 10 down days of 1% or more. The S&P 500 benchmark is now down 6% or so and, can you believe it, everyone is still blaming the labour numbers and how the Fed was going to tighten three times or more.

Sorry folks there is no secret sauce. The valuations, if fair, should still justify higher prices. However, the rate at which revenues have risen is slowing. We will see a blip due to the taxes but otherwise if revenues are rising steadily the odd interest rate adjustment should not be catastrophic. This probably means equity has run ahead of itself. What is causing the runoff I believe is the uncertainty of the debt ceiling. Funding runs out at 12.01 am Friday and maybe this uncertainty has spooked the equity market.

What we also have in the equity market is the unknown quantity of machine learning automated trading. How the algos cope with a slight rise in volatility and selling may not go the way the programme is supposed to work, and we probably are seeing this effect. Remember there is no secret sauce and the algo programmes are all roughly the same so once a direction is established that’s where the market goes. As we crank up volatility, the machine has learnt what to do in declining volatility, but this is all foreign. Look for the hedge fund returns over this period, the returns should make interesting reading.

And as we go into the close, there is a suggestion of a flash crash as the machines pummeled the exchange. Where is the learning for what happens with rising volatility in the equity market? The same problems continue to persist. Machines struggle when vol rises. Today’s closes are the steepest decline since 2011. The Vix closed at 37, the single largest rise since 1990. During the Great Recession of 2008/2009 THE Vix rarely moved into the high 30’s.  So today was rather unusual and exacerbated by those operators running machine learning programmes that were all looking for an exit without a bank looking to take on risk. The regulators have what they want – a market that only knows one direction.

Earnings are solid with those companies that have reported showing earnings have climbed 13.6% in the fourth quarter.

On the day, bonds staged a neat rally. The market was heavily oversold Friday and Monday. The bond market traded back some of the selloff. The shorts covered, and the bond curve steepened a little again. Ten years rallied back to 2.75% a mighty effort. Issuance of treasuries is set to rise significantly this year and that will push rates higher. Today’s rally, however, is technical in nature, was in sympathy with the weakness in equity (often bonds rally when equity weakens) and will probably be short lived. Look to hold the shorts or sell into the rally.

The gorilla in the room is the debt ceiling. A bipartisan bill that addresses the issues relating to the dreamers is about to be put forward and this could break the impasse. However, should the impasse continue then the next hurdle for funding comes in early March and once again markets will become very nervous around that date.

For the Fed, this period will be challenging. Their tools are now fewer than a few months ago. Where the Fed could step in and purchase bonds they are now a seller and it also appears as though many central banks are now on the sidelines. So, the distortions caused by the buying of central banks can no longer persist and the markets are set to normalise. How quickly they get there is anyone’s guess. But the old adage may well hold down by the stairs and up by the elevator. For Powell, these next few months will be challenging especially as the markets look to normalise.

For investors, this should be an appealing time.  Research and effort should lead to better returns for investors. There will be less crowding out by buyers that have to buy (central banks) and real returns should improve as investors will now be better rewarded for risk. The anomalies will be fewer. The risk reward payoff should become relevant again.

Recap. 

Equities: The S&P 500 fell 4.1%. The Dow fell 4.6%. The Stoxx 600 fell 1.6% and was down.

Currencies: The pound fell 0.8%, the euro fell 0.5%, the Bloomberg Dollar Spot Index was up 0.3%.

Bonds: The ten-year hit 2.75%. The 2-year closed at 2.12%.the ten-year bund closed at 0.67% and the UK gilt closed at 1.555% and the OAT closed at 0.993%. The U.S. curve closed 2/10 at 67.9bp, 2/30 at 95.6 bp and the 10/30, closed at 27.5 bp. The U.S. 5-year closed at 2.49. Expect some volatility in the curve and quite possibly expect some flattening again.

Commodities: Gold fell 0.1% and WTI fell 2.2 %. Copper rose 1.8%.

Aussie Market Today.

The carnage in the equities market is set to continue. Credit indices for the weaker credits has moved wider whilst investment grade remains relatively stable given the circumstances. Equities are set for a bad day at the open but should see some buying interest at lower levels.

Bonds are set to open stronger on the back of U.S. bonds and a weak equity market. I expect 10 years to be about 6-7 pts stronger before we see profit taking and selling. This may be a good opportunity to sell into a strong market and look to cover at a later date.

The Aussie looks set to be weak on the day.

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