The World Bank's use of the term "disappointing" to describe global growth helped spark a more cautious tone Wednesday.
While markets are nervous about many possible paths for the Fed to take, the one that involves rapid balance sheet reduction is not in the cards.
We examine recent breakouts in the wake of Wednesday’s “red day."
After 88 Points, Some "Give Back" Is Normal
Given the S&P 500 pushed 88 points higher between May 15 and June 10, traders were looking for a catalyst to lighten up a bit. On Wednesday morning, the World Bank described growth as "disappointing." From the World Bank Global Economic Prospects report:
Developing countries are headed for a third consecutive year of disappointing growth below 5 percent, as first quarter weakness in 2014 has delayed an expected pick-up in economic activity, says the World Bank's latest Global Economic Prospects report, issued on June 10, 2014… The global economy is expected to pick up speed as the year progresses and is projected to expand by 2.8 percent this year, strengthening to 3.4 and 3.5 percent in 2015 and 2016, respectively. High-income economies will contribute about half of global growth in 2015 and 2016, compared with less than 40 percent in 2013.
One Day Does Not Make A Trend
On June 8, we provided some evidence of resurfacing bullish conviction. As shown in the chart below, Wednesday's weakness did little to disrupt the improving look of the S&P 500's weekly chart.
Fed Has No Plans To Reduce Bond Holdings
The Federal Reserve has printed billions of electronic dollars in recent years. The fresh greenbacks were used to buy bonds, and thus inject new cash into the financial system. Logic tells us that if Fed demand for bonds has helped suppress interest rates, any attempt to enter the market as sellers could result in a big spike in interest rates. From Bloomberg:
Federal Reserve officials, concerned that selling bonds from their $4.3 trillion portfolio could crush the U.S. recovery, are preparing to keep their balance sheet close to record levels for years…Officials worry that such sales would spark an abrupt increase in long-term interest rates, making it more expensive for consumers to buy goods on credit and companies to invest, according to James Bullard, president of the Federal Reserve Bank of St. Louis.
Spring Of Indecisiveness Hard On Hedge Funds
The combination of tepid growth and Fed tapering made for a somewhat trendless environment in the spring. The markets, for the most part, have been in "no clear leaders" mode for some time, which has made the job for hedge funds more difficult. From The Wall Street Journal:
Even now, many of these so-called stock pickers are still struggling. Hedge funds earlier this year suffered back-to-back monthly declines in March and April for the first time in two years, according to researcher HFR Inc. These funds hadn't turned in two consecutive losing months since April and May of 2012, HFR said.
Investment Implications - Volatility To Ignore
Volatility is the enemy of investors. To tame the volatility beast, we need to discern between "volatility to ignore" and "volatility to respect." Thus far, the "give back" in stocks falls into the ignore category. For example, Wednesday's session did little to alter the equity-favorable look of the stock/bond ratio below.
The tweet below tells us the market has a bit more breathing room than it had this spring, which enables us to give our positions a little more rope from a volatility perspective.
Consequently, we have made no changes to our allocations this week. We continue to hold stocks (NYSEARCA:SPY), leading sectors (NYSEARCA:XLK), and bonds (NYSEARCA:TLT). As long as any weakness remains in the volatility to ignore category, we will hold our stakes while keeping an eye on the market's ever-evolving tolerance for risk.
Disclosure: The author is long TLT, SPY, XLK. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.