posted on 12 March 2017
by Lance Roberts, Clarity Financial
Last week I reviewed Why This Market Reminds Me Of 1999:
This past week, several areas of the market began to unravel.
First, the bond market was hit hard as expectations of a Fed rate hike next week sent money scurrying out of bonds.
However, this recent pop in rates, when combined with a stronger dollar which drags on corporate exports (roughly 40% of earnings), has historically been an excellent opportunity to add to bond exposure. As shown below, the Federal Reserve, in their eagerness to hike rates, are once again likely walking into an "economic trap."
Also, whatever causes the next reversal in rates will coincide with an unwinding of the still very massive speculative net short in bonds.
I agree with Albert Edwards on his discussion of rates.
Of course, it isn't JUST the Federal Reserve hiking rates which pose a risk to the markets. There is also this little problem that suggests rates will remain low for a very long time to come.
Secondly the oil market. As I discussed a few weeks ago:
Of course, with oil companies rushing out to increase drilling following the recent pop in oil prices, it was only a function of time until someone woke up to the reality of the build in still bloated inventories. (Also, despite President Trump's exuberance over the building of the XL Pipeline, the last thing oil companies need right now is another 800,000/bbl's a day in supply.)
Importantly, despite the recent decline in oil, the massive net-long position in oil remains which suggests further downside in the weeks ahead.
This is important because the rise in oil prices has been the support for:
As I have discussed in past missives, the detachment between oil prices and the underlying fundamentals pose a significant threat to those that piled into energy-related stocks in recent months. With everyone on the long-side of the energy trade, the reversal will likely be brutal.
Third, the spike in rates also impacted other interest rate sensitive sectors of the market which have been performing well since the beginning of the year.
REIT's, Staples, Utilities, Preferred Stocks and, of course, Bonds were all hit hard this past week.
However, despite all of this reversions eruption of activity, the markets remained relatively unfazed with volatility remaining suppressed. As Mark DeCambre wrote on Thursday:
While it's not a record, it is an extremely long time for volatility to remain suppressed. As shown in the chart below, such complacency does not, and has not, lasted forever. I have included the 10-year Treasury rate as spikes in the VIX, which have corresponded with declines in stocks, have also correlated to declines in interest rates as money rotates from "risk" to "safety."
This is a very strange state in the market currently.
No matter what happens, seemingly there is little concern. But it is that lack of concern that historically turned out to be the problem.
With the debt ceiling debate, Fed rate hike and Dutch elections all coming to fruition next week, there are plenty of potential catalysts to create a pick up in volatility.
We lifted some profits out of portfolios last week which has been helpful in lowering portfolio volatility. However, depending on what happens this coming week, there may be more work that needs to be done.
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