After one of the slowest starts to a year in the last 100 years market volatility is coming back. Just as everyone is about to head off to the beach things are getting interesting. Why do Federal Reserve officials keep trying to change policy in the summer? It is a very illiquid time of the year and made only more so by the changes in Dodd Frank. This illiquidity and the looming Presidential election are going to complicate things for the Federal Reserve.
It is worth reminding you of our last post and the ideas of investing in a central bank dominated world. As long as central banks maintain current policy asset prices will continue to climb. A slow down in balance sheet growth would bring slower asset price growth much as it has in the United States since last October. Investors are nervous but policy is still accommodating. History has shown that markets do not turn on a dime on the first rate hike by the Federal Reserve. It is the second rate hike that begins to slow markets. Rest assured Fed officials have made it clear that they will catch markets when they fall. We may be in a period of subdued returns as markets show signs of slowing their ascent but not turning lower. We are long but have our guard up.
Bond yields have begun to move higher in the last month. Could the market be trying to force the Fed’s hand into raising rates? The Fed will not want to lose control of the bond market. As David Stockman, former Director of the Office of Management and Budget for the Reagan White House said last month in his blog, the market is in a game of chicken with the Fed. The Fed will want to set the tone for the bond market but may be hampered by the looming 2016 Presidential election. If the Fed raises rates in a weak economy they could be blamed for triggering a recession in an election year. Remember that Congress has oversight of the Federal Reserve. The Federal Reserve is not going to want to be blamed for a recession and its influence on the election. We look for them to become more opaque in their guidance. Will the Fed have the courage to lead and raise rates in 2016? We have our doubts.
What is going on here plain and simple is a one-sided game of chicken. The robo-traders and hedge fund buccaneers on Wall Street press the market higher on virtually no volume or conviction whenever macro-economic weakness presents itself, virtually daring the Fed to maintain is ultra-accommodative stance still longer. – David Stockman
Amazingly, the market is still stuck in an increasingly tighter range and the tension continues to build. The broader range of the S&P 500 is 2040 -2120. The 2080 area and the 100 Day Moving Average will be watched closely. Markets tend to break out the way that they came in but this one had a false breakout to the upside in the last couple of weeks. That increases the odds of a break down. The bulls will look to 2080 on the S&P 500 to hold and if the S&P breaks through there then key support will be the bottom end of the broader range with 2040 and the all important 200 day moving average as support. A sustained break below that area would bring out more sellers but until then the prevailing trend is higher. While metrics have the market at historically high valuations we don’t see asset prices turning lower until central bank policy changes.
Is this the “new normal boom”? Robert Shiller, Nobel laureate from Yale University has coined the phrase the “new normal boom”. This is not your father’s bull market based on an ever increasing greed and exuberance. As this market has edged higher so has the anxiety associated with it. We are long but increasingly nervous.
“I call this the ‘new normal’ boom — it’s a funny boom in asset prices because it’s driven not by the usual exuberance but by an anxiety. –Robert Shiller
We have had low durations in our bond holdings and that has helped. Keep your durations low as the market finds its levels and the market adjusts. We suspect that any move higher in interest rates by the Fed may not be long in nature. Stocks will continue to be subdued until they are not. Things could get hot this summer. Watch your levels. The 200 day moving average is the fulcrum between a bull market and a bear market.
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd Blankfein
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.