The Stock Market: Going Into A Higher Volatility Regime

Summary

• The stock market had a very volatile week as radical uncertainty seems to be dominating investors' minds.
• The future is just so uncertain and we still don't really know what the Federal Reserve is going to do in its efforts to lessen inflation.
• But, there are many, many other factors that could impact the market, like the Russian invasion of Ukraine, the China problem with COVID-19, supply chain problems, and energy problems.
• Investors are going to have to live with this environment and because of it, some seem to be moving back toward value investing, a technique that was abandoned by many during the last decade.

Pgiam/iStock via Getty Images

"We're going into a higher volatility regime when fundamentals matter again."

This quote is from Aashish Vyas, investment director at Resonanz Capital, in the Wall Street Journal.

"It does seem like we are at a systemic shift."

A measure of volatility, the VIX index, was in the low 30s for most of the past week. This is at least ten points above where the index has been in recent weeks.

The swings in the marketplace are getting more and more severe.

Weekly stock prices (Wall Street Journal)

The dominant factor in investors' minds right now?

Radical uncertainty!

There are a lot of knowns that investors are having to deal with in making their investment decisions.

But, there are a lot of unknown unknowns that are blocking any clear vision of what is in the future for stock prices.

And, as one reads the analysis of the current situation we see that investors are moving from the staples that they have feasted upon in recent years.

For one, favorite technology stocks have been taking a hit.

Investors have "soured in shares of everything from software and semiconductor companies to social media giants."

We read

"The worrying declines in tech and growth stocks mark a dramatic shift from recent years."

"Throughout the month, investors have ditched shares of some of the biggest tech companies, which had been stock market darlings for much of the past decade, and let the market higher from its March 2020 lows."

" Within just a few months, some of the most reliable winners of the past few years have morphed into losers."

Big Change From Fed

One of the biggest changes that has occurred in the past month or so, has been the behavior of the Federal Reserve and the market's acceptance of this change as a reality.

Interest rates are going higher, there seems to be no doubt about this fact.

In March, the Federal Reserve oversaw a rise in the effective Federal Funds rate to 0.33 percent.

The betting seems to be that the Fed will raise the target range for the Federal Funds rate by 50 basis points at the Fed's May meeting of the Federal Open Market Committee. Roughly speaking, this will take the effective Federal Funds rate up to around 0.83 percent.

At least two more increases are expected this year.

The yield on the 2-year Treasury note closed over 2.90 percent on Friday, up from around 0.75 percent at the start of the year.

The yield on the 10-year Treasury note closed right around 3.00 percent on Friday, up from around a little over 2.00 percent in early January.

"These higher yields have dented the allure of tech and growth stocks, making shares of firms whose profits may lie further out in time less attractive."

But, we don't know how the Fed is going to achieve all its expected increases and we don't know yet how it might manage its balance sheet.

But, That Is Not All

The story does not end here.

We have the situation unfolding in Ukraine. What will happen here?

We still have concerns about another round of COVID-19 surprises.

Supply chains seem to be in a mess.

Commodity prices are rising and the end does not seem in sight.

The Biden administration still seems to want to push demand-side fiscal efforts to stimulate the economy, something that may not play well with the higher rates of inflation and Federal Reserve tightening.

Furthermore, the value of the dollar has risen tremendously in the past few months. The euro, for example, only costs somewhere between $1.05 and $1.06.

Money seems to be finding its way into the United States, but how is that going to impact the economy and policymakers in the rest of 2022 and into 2023?

And, there are many things that are not even on the radar that could take place.

Two months ago we had no idea that Russia was going to invade Ukraine.

What might explode in the middle east?

What about China and its fight against the COVID-19 virus?

Finally, what might happen to inflation?

The Fed's preferred measure of inflation, the personal consumption expenditure index measure of core inflation, which excludes the volatile food and energy costs, rose by 5.2 percent, year-over-year, in March.

We just don't know what is going to happen to inflation, given all the supply chain problems, the oil and gas problems, and re-alignment taking place in the world.

The Foundation For The Next 18 Months

To me, the major known unknown factor that will be dominating the next year and one-half will be the actions of the Federal Reserve.

The Federal Reserve's movement toward the fight against inflation became a reality in December 2021.

Investors in the stock market really began to use this move as an excuse for the change in mood that affected the stock market. And, the S&P 500 index hit its last historical high on January 3, 2022, at 4,288.

S&P 500 Stock index (Federal Reserve)

The S&P 500 closed on Friday at 4,131.

And, for the next 18 months are so, the Federal Reserve is supposed to keep raising its policy rate of interest.

The Federal Funds rate could be in the 2.00 percent to 2.50 percent range by the end of this time period and the yield on the 10-year Treasury note could be around as high as 4.00 percent.

Some analysts would argue that this would not be a significant enough move to actually represent a real restrictive monetary policy.

But, even if these rates are achieved, what is going to be the reaction in the stock market?

Will investors move out of stocks in a major way?

Could the Fed avoid attempting to lessen a major downward move in stock prices?

Could the Biden administration stay away from a major downward shift in the stock market?

And, this scenario doesn't include all the other things that could happen over this period of time.

This is what radical uncertainty is all about.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.