Last week we wrote about how a sudden change in one asset class can cause a ripple affect by affecting trading models that run on algorithms. This week the CEO of Goldman Sachs, David Solomon, said:
“Some of this is the result of programmatic selling because as volatility goes up, some of these algorithms force people to sell,”
The VIX, which is the market’s expectation of 30-day volatility based off of the implied volatilities on S&P 500 options, broke above 15 on October 8, 2018 and had been below 15 since July. On October 11, 2018 the VIX went up to 25.97 and the following 6 trading days brought swings that we haven’t seen in a while.
For October the S&P 500 is down 4% as of yesterday and we were buying for our clients this week. We feel that this was the right move because we feel the economic data is still strong with the exception of US housing in which we are in wait-and-see mode. If the bond market saw a recession on the horizon, yields would head lower and instead they are rising.
Ultimately we believe that the sudden rise in US treasury 10 year yields to the most recent high of 3.25% from under 3% all year and a low of around 1.46% in July 2016 is causing a tantrum that will ultimately settle down.
Putting this into context the high of 3.25 represents a 122% rise since the 2016 low and is up around 24% year to date. These percent changes are large and as the US FOMC reconfirmed their commitment to higher interest rates, the equity market will try to find out proper valuations and effects on the new reality that it finds itself in.
This means that we expect volatility to continue and the markets will continue be volatile as well. Until yields start to decline again due to recession fears, this ultimately means an improving economy and is positive for stocks.
Having said that it is positive for stocks in general but not all stocks are created equal. For example companies that are heavily indebted or are growing by acquisition will face higher interest rates which will interest expenses to rise while hurdles for new deals will be higher and will likely slow the acquisition phase.
Further, the US FOMC meeting minutes were released Wednesday and reiterated their strong view on the US economy and confirmed their stance on gradually increasing interest rates. This ultimately has created fear in the market as it is being interpreted as too soon to raise rates however we must keep in mind that much of the economic data coming out of the US with the exception of housing and perhaps retails sales has remained strong. On the periphery China, emerging markets and Italy are continuing to be concerns along with the European Central Bank easing off of their stimulus however remember that the US GDP is roughly 70% domestic.
This week was fairly data heavy in the US as well.
On Monday we saw US retail sales ex-autos down 0.1% with expectations of +0.4%. It also had a negative revision to the previous month by -0.2%.
On Tuesday US Job openings increased and for the fifth month in a row there are more job openings than there are unemployed. With an unemployment rate of 3.9% and wages slowly rising. This points to a strong economic environment with job creation and as we’ve pointed to before, a setting for an increase in economic transactions which points to an improving economy.
UK number of employed missed expectations however the year over year number saw a rise and was all from full time employment which is positive.
US Mortgage applications, building permits and housing starts were all lower but the bright spot was single family building permits were higher. It was the multi family building permits that brought down the number. On Friday we saw existing home sales decrease by 3.4% from the previous month and are down 4.1% from a year ago. Distressed sales were down to 3% from 4% a year ago (positive signal). Commentary in the release was that first time home buyers are having difficulty finding a place that is affordable.
As interest rates continue to climb, mortgages payments will buy less house for the same payment. Will the labour market improve to fill in the gap in affordability? Signs point to yes and I heard two managers this week say that they expect the housing market to pick back up however they expect that it may take 6 months to a year or so before it does.
Internationally, China GDP was soft but the government stepped in saying that the valuations in the stock market are not properly reflected and encouraged banks to increase lending to private companies. This turned markets around from the negative print to be positive.
Italy has decided to propose a budget that is clearly against EU membership agreements and will continue to cause European volatility.
While the Canadian economy has been strong, retail sales showed weakness and so did housing starts. We remain cautious on the Canadian economy as consumer debt levels are high and look for less indebted economies in times of rising interest rates.
In summary, where does this leave us? While this seems like a lot of negative news this week, we still see a strong overall US economy and strong labour market believing that inflation will start to rise. This is the reason that we are positive on the US markets however we continue to be patient about putting money to work and look to buy on sizable pullbacks. We are focused on US economic exposure and short term on bonds.
Our Weekly Wealth Tip is to is based on the continuing topic of rising interest rates. We recommend shopping around when renewing your mortgage. Lenders, including banks, mail out to their customers renewal forms however they are usually the posted rates yet there is often room for a lower rate. It is worth negotiating with that lender and seeking comparative quotes in order to gain leverage.
As TK Dale Wealth Management is a Mortgage Agent we have the ability to shop around on your behalf for the mortgage that most suits your needs at a great rate. Call or email us if you find yourself in this situation.
Until next week.
This report is provided by TK Dale Wealth. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. This report contains economic, investment and market analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. TK Dale Wealth Management is not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.