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Macro Commentary: Interest Rates, Inflation, and Volatility

Macro Commentary: Interest Rates, Inflation, and Volatility

| February 14, 2018
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Interest Rates & Inflation:

  • Throughout much of 2017, many investors were concerned about the flattening of the U.S. Treasury yield curve; there was concern that continued flattening could lead to an inverted yield curve.  Historically, inverted yield curves, specifically when the two-year Treasury yield is higher than the ten-year yield, have preceded recessions.  Each of the four recessionary periods since 1980 have occurred either while the yield curve was inverted or within one year of when inversion occurred. (Source: The Inverted Yield Curve)

  • A steep yield curve, on the other hand, often indicates a period of inflation, which is often associated with strong economic activity.  Since the beginning of 2018, the yield curve has steepened. The spread between the ten-year and two-year Treasuries has risen from 54 basis points on 1/2/18 to 69 basis points on 2/2/18.

  • According to earnings reports, there has been strong economic activity.  FactSet recently stated in their Earnings Insight report, "For Q4 2017 (with 50% of the companies in the S&P 500 reporting actual results for the quarter), 75% of S&P 500 companies have reported positive EPS surprises and 80% have reported positive sales surprises.  If 80% is the final number for the quarter, it will mark the highest percentage since FactSet began tracking this metric in Q3 2008." (Source: Factset - Earnings Insight.)

  • While investors are concerned over rising interest rates and inflation, long term Treasury, as measured by the 30 Year Yield Index (TYX) are close but still below the 2016 post Presidential Election Rally high of 3.20% reached in 2017. The TYX is currently at 3.125%.

Rising interests rates, a stronger than expected jobs report, and increased wages have all been given as potential causes for the recent sell off in U.S. Equities – the speculation is that investors fear that a strong employment market will lead to inflation and cause the Fed to accelerate the pace of rate increases.  However, these concerns are in many ways in opposition to the concerns of last year when investors feared that a flattening yield curve would lead to inversion and ultimately recession.  Thus far in 2018 the yield curve has been moving the opposite direction, and yet this has also been blamed as a cause of the sell-off in U.S. equities.

Volatility:

  • The CBOE SPX Volatility Index VIX spiked roughly 90% (+15 points intraday) on Monday February 5th.  This is the highest level we have witnessed on this chart since January 2016.

  • Based on the market's expectations of future volatility using S&P 500 index options, the market expects the S&P 500 to move +/- 10.68% over the next 30-day period.  But...

  • The last time the VIX crossed 32 was on January 20, 2016. Although the market did experience a brief spell of volatility into February 2016, the market did rally from there.  One month after the VIX touched 32 on January 20th, the S&P 500 SPX rallied 3.14% (Jan. 20, 2016 - Feb. 19, 2016).  Three months after crossing 32, the market appreciated 13.07% (Jan. 20, 2016 - April 20, 2016).  This is to say that a rise in volatility is not always followed by a massive down shift in the equity prices.  If we do see the market continue to correct from here, we will utilize the charts, indicators, and relative strength rankings to assist in navigating the market and stay objective.

Until next time, cheers!

Jim

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