CNBC: 7:22AM EST
The stock market (SPY, DIA, QQQ, IWM) got out the gates to a bit of a bumpy start as they begin the holiday-shortened week. CNBC has a piece out reminding investors that September is typically the worst calendar month in terms of investment returns:
According to the Econoday Economic Calendar, there is plenty of Fed speak coming up in over the next few trading sessions. The biggest economic data point of course will come on Friday morning with the NFP jobs report. Here's a quick peek at the consensus figures:
Daniel Nevins, CFA penned an interesting piece on SA over the weekend that may have escaped readers' attention. The title, "The Latest News From The CBO Is Bullish For Bond Investors", puts the conclusion right out there.
The author mentions that he'll likely do a follow up with visuals from the CBO report, and I sure hope that he does.
Mr. Nevins works to convince his audience that the current baseline CBO projections for the state of US fiscal affairs is extremely unlikely based on unrealistic assumptions. To quote directly from the piece:
The SA contributor then goes on to share that the optimistic debt loads for the US thirty years hence are between 210 and 230 percent of the then-GDP, compared to the current level of 76% held by the public.
It does not require too much creativity to then imagine that interest rates will soar under such a scenario, which would of course result in sharp losses for fixed income instruments. Mr. Nevins takes a different view. He believes that the well-honed wheels of financial repression will kick into gear, and concludes that these rather dire projections from the CBO actually represents good news for bond (IEF, TLT, AGG, LQD) investors. He goes on to share some historical reasons for his conclusion, such as regulations on commercial banks and central bank precedent.
I believe that the next thirty years or so is going to be quite different from the last thirty years. There is plenty of reason to believe that many of the forces that have been helpful to returns since, say, 1982 (interest rates, debt levels, falling effective corporate tax rates, falling dollar, deregulation, favorable demographics) will in many cases reverse course: tailwinds will become headwinds.
That is not to say that the entire financial world will experience Armageddon, but it does mean that past performances by financial markets may be very difficult to replicate for passive investors. As such, it is important to understand that volatility may shift radically in its characteristics.
As far as the long weekend is concerned, the unfavorable market action we're seeing near the Tuesday open really took root during the Tuesday pre-market rather than the sleepy Monday session. It is worthwhile to remember that it was trade developments with Mexico that helped the SPX to climb over the 2,871 hurdle that formerly represented all-time highs. For now, the markets may view the Canadian developments less as cemented policy and more as jockeying for the US to get the best trade deal.
Spot VIX has taken a bump, but other than the M1, the term structure is pretty unfazed by the latest round of trade sparring. For those considering how they want to position in the volatility markets (VXX, SVXY, UVXY), I would be looking principally in two places: realized S&P vol, and also for the time being implied vol in international stocks such as Canada (EWC) and perhaps China (FXI). I believe that it is these foreign markets that will put a cap on trade-related implied vol prospects for the tamer US implied vol space.
The EWC, which allows investors to trade a basket of Canadian stocks, is seeing a meaningful divergence between implied vol and realized vol. This makes sense given the recent trade developments with the nation's largest trading partner. But again, this really only creates sustained volatility across broader segments of your portfolio if realized Canadian vol decides to pick up.
It is entirely possible that traders of both volatility and the underlying assets will respond to headline risk here in a collected manner, confident that the process involves bickering on the front end followed by swift(ish) resolution that is decidedly not overly dramatic or detrimental to the economy as a whole.
If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, we thank you for your ongoing contributions in the comments section.
With respects to the discussion in the Shout Out segment of this Bulletin, what are your thoughts?
- How has policy shaped the risk-return tradeoff for the US investment community over the last 35 years or so?
- What shifts do you believe are likely to transpire over the next investment generation?
- What mitigating factors do you see smoothing out some of these new developments, be they positive or negative?
Thank you for reading.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I actively trade the futures and options markets, potentially taking multiple positions on any given day, both long and short. I also hold a more traditional portfolio of stocks and bonds that I do not "trade". I do believe the S&P 500 is priced for poor forward-looking returns over a long timeframe, and so my trading activity centers around a negative delta for hedging purposes.