Volatility and Goldilocks

The Federal Open Market Committee (FOMC) Minutes from the April 29-30 2014 meeting were released this week. While there was not much in the way of surprises in the minutes there were two items that caught our eye. The first was that the committee noted that a couple of participants felt that conditions in the leveraged loan market had become stretched. We were early on into leveraged loans the past couple of years and that has served us well. Some clients will now see a reduction in that area in the coming months as we wish to back away from any repercussions associated with a bubble in leveraged and covenant lite loans.

The second item that caught our eye was the committee’s reference to declining credit spreads which imply an increase in investors’ appetite for risk. The committee also noted that the low level of expected volatility is also implying an increase in investors risk appetite.

While the Technicals of the broader market and the S&P 500 do not indicate any imminent failure small cap stocks continue to maintain their divergence from their large cap brethren. Market participants seem be plowing money into large caps and “safer” stocks while small caps are abandoned. What we may be seeing here is that institutional investors are forced to invest client’s money and are placing that money into safer assets like large cap stocks while a stealth bear market takes place underneath in small caps and biotech. When confusion reigns we turn our eyes to the bond market. The bond market is not playing along with a new high in equities (S&P 500 and Dow Jones) and is indicating a move lower in stocks. It gives us reason to pause when equities seem to be ignoring clues emanating from bond market.

Bill Dudley, the President of the Federal Reserve Board of NY, is a very influential member of the FOMC. When he speaks we listen intently. In a speech this week Dudley noted that he expects rates to stay lower long and well below the historical average of 4.25%. In private meetings Ben Bernanke former Chairman of the FOMC reportedly has stated much the same and that he does not expect rates to normalize in his lifetime. Strong words.

Last week we noted that the summer may be bumpy we think that any retreat by stocks will be backstopped at some point by the Federal Reserve. This week NY Fed President Dudley volunteered that the Fed will be more aggressive in raising rates if markets allow and less aggressive if they do not. The market is calling the tune and the Fed will apply the brakes or the gas depending on the market’s reaction to Fed policy. We think that the Fed will allow some volatility but not just too much. It’s Goldilocks monetary policy. Look for trading bands to widen over the coming months. The last three months have been some of the least volatile since 2006.

The Bank of England is considering whether to raise rates. What happens in England is a precursor to what happens here in the US. Keep an eye on the Bank of England. Treasuries and Gold continue to be our risk temperature gauge. Watch the yield on the 10 Year US Treasury at the 2.5% level and $1300 on gold.

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

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